Over the past decade, threats of restrictive trade policy and geopolitical risks have emerged and intensified. There has been a series of adverse shocks to globalisation (Aiyar et al. 2023): the trade conflict between China and the US, Brexit, the Covid pandemic, and Russia’s war of aggression against Ukraine. These shocks can affect bank credit provision. Banks are important for financing international trade and providing credit to the real economy.
Trade policy and uncertainty shocks might even be reinforced by banks, domestically and internationally, by transmitting financial stress through lending and liquidity flows (e.g. Peek and Rosengren 2000, Cetorelli and Goldberg 2012, Schnabl 2012, De Haas and Van Horen 2013, Niepmann 2015, Niepmann and Schmidt-Eisenlohr 2017, Amiti and Weinstein 2018, and Federico et al. 2020).
The International Banking Research Network (IBRN) initiated a project where country teams investigated how trade uncertainty, fragmentation events and deglobalisation shocks are amplified through the supply of credit. Studies use granular confidential regulatory data on banks to show how fragmentation shocks reallocate and sometimes reduce credit supply through banks. This reallocation both reinforces fragmentation and influences the pattern of consequences from trade disruptions. Studies draw on detailed information about the specific shocks to firms (to capture the demand side) and banks’ exposures to those firms, along with bank characteristics (to capture the supply side).
Specific episodes explored include the effects of Russia’s invasion of Ukraine in 2014 on Italian banks (Federico et al. 2023), of the Brexit referendum on German banks (Imbierowicz et al. 2023), of retaliatory trade restrictions from China onNorwegian banks (Cao et al. 2022), of the euro area sovereign debt crisis on Portuguese banks (Bonfim and Fèlix 2023, Pedrono 2022), and of the increase in uncertainty since 2016 from intensifying trade tensions between the US and China on US, Chilean, and Mexican banks (Correa et al. 2023, Margaretic and Moreno 2023, Bush et al. 2023). Other work looks at changes in services trade in a broad range of economies from 2014 through 2019 (Lloyd et al. 2022 for the UK) or at the geographic specialisation of banks from 2006 to 2019 (Pedrono 2022).
Trade fragmentation spills over into bank lending activity
All studies confirm that banks’ credit supply responds to trade fragmentation shocks and increased uncertainty. When a fragmentation event occurs, banks decrease their supply of credit. This effect goes beyond the firms immediately affected as banks also restrict credit to firms which are not directly exposed to the event. Hence, the initial shock is amplified across the universe of bank borrowers.
The magnitude of the decline in credit differs across countries. As regards large US banks, those exposed to trade uncertainty reduce credit originations by 0.5 percentage points, which compares to an average growth rate of 4.2% prior to the shock (Correa et al. 2023). A standard deviation increase in Italian bank exposure (around 0.45 percentage points) to a trade shock is associated with a 0.8 percentage point decrease in credit supply (Federico et al. 2023) and high-exposure Norwegian banks decrease their lending in all lending categories by 3-6% following the trade shock (Cao et al. 2022). Given the differences in the type of shock and the measures used for analysis, the results overall suggest a generally material effect on bank credit supply.
Trade shocks are transmitted through increased risks of loans on banks’ balance sheets. On impact, trade shocks have adverse effects on the financial soundness of firms. Firms experience a decline in revenues, lower liquidity, and a higher propensity of loan default (Federico et al. 2023).
Banks respond to higher risks and uncertainty arising from international trade shocks by taking precautionary measures. They increase loan loss provisioning and reduce risk taking. This manifests as a contraction of credit to riskier borrowers, and not just to those exposed directly to the initial uncertainty.
This type of mechanism is identified from analyses of banking responses in Chile, Germany, Italy, Norway, and the US. US banks, for example, contract credit supply more for firms that are more informationally remote, that strongly rely on trade finance, are that are internationally integrated into global value chains. Firms facing larger information asymmetries, such as having shorter banking histories and being foreign firms, are also affected more. US banks which are exposed to higher uncertainty curtail loans specifically designated for investment.
Borrowers relying on financing through banks exposed to trade uncertainty are unable to fully substitute reduced lending with alternative external sources of credit. Accordingly, a contraction of credit supply can have adverse impacts on firms in terms of lower ability to borrow, capital expenditures, and asset growth (Correa et al. 2022). In Chile, banks reallocate credit from firms in nontraded sectors to those involved in global value chains, and to a lesser extent, to importers who are exposed to countries exhibiting an increase in trade uncertainty (Margaretic and Moreno 2023). Portuguese banks more exposed to foreign firms decrease loan supply during crises but increase lending towards domestic firms (Bonfim and Félix 2023). In Germany, banks reduce credit supply to less profitable firms following the Brexit events (Imbierowicz et al. 2023). Some subsidiaries of large multinational corporations can access internal cross-border capital markets in response to the credit supply shock, mitigating some of the negative real economic outcomes. Overall, these banking channels add to the broader set of effects of Brexit on UK firms (Bloom et al. 2019).
Some types of banks are more prone to credit supply adjustments
Beyond their direct balance sheet exposures to the firms impacted by trade events, the characteristics of banks matter for the magnitude of their credit supply response to international trade disturbances.
The resilience of banks matters for their response to shocks. Large US banks with lower levels of capital and a higher dependence on market funding reduce lending by more than their better capitalised peers or those relying more on retail funding. Similarly, relative to their peers, German banks with lower levels of capitalisation and lower return on assets tend to have larger reductions in their credit supply to firms which are not directly exposed to the event. The adjustment by Chilean banks which are smaller is to extend new loans with shorter maturities and higher interest rates.
The geographic presence of bank affiliates in foreign countries has an impact as well. Generally, the contraction of credit is larger for banks with business models that support global trade as measured by the extent to which banks engage in trade finance and have loan exposures to foreign residents. The UK study looks at differences across banks with and without foreign affiliates (Lloyd et al. 2022). Banks without foreign affiliates decrease cross-border lending. Those banks with a foreign affiliate decrease intragroup lending, but increase direct cross-border lending. Barriers to competition have the strongest impact especially for banks which have already established a presence in the other country. The geographic specialisation of banks also determines the relationship between bilateral cross-border lending of banks and bilateral trade of firms: more geographically specialised banks provide more cross-border lending to firms in the same industry in which they specialize, but less so following an adverse trade shock (Pedrono 2022). Similarly, under increased trade uncertainty surrounding the renegotiation of the North American Free-Trade Agreement (NAFTA), foreign banks operating in Mexico with their parent headquartered in the US and Canada reduced credit supply, while those with foreign parents elsewhere, increased credit supply (Bush et al. 2022).
Concluding remarks
Trade policy uncertainty and fragmentation events have become major concerns for global production and trade (Fajgelbaum and Khandelwal 2021), with simulations showing that these events could lead to substantial reductions in economic growth (Bolhuis et al. 2023). Cross-country studies organised by the International Banking Research Network emphasise additional financial-sector factors that can affect credit supply and output effects of fragmentation events. Adverse trade shocks affect banks’ borrowers, and the effects of those shocks are amplified through contractions in credit supply. Importantly, these effects go beyond the specific firms that are directly affected by the trade-related events. This body of research shows that shocks to banks, which derive from borrowing firms’ exposures to trade and trade uncertainty, generate ripple effects. A decline and reallocation of bank credit supply can reinforce fragmentation and potentially slow the adjustment of firms to trade shocks. A general conclusion from very detailed studies is that banks that are more resilient – with diversified portfolios, better capitalisation and liquidity buffers –are better placed to absorb adverse shocks and maintain lending, containing some of the adverse spillovers from trade shocks through credit supply.
References
Aiyar, S, J Chen, C Ebeke, R Garcia-Saltos, T Gudmundsson, A Ilyina, A Kangur, S Rodriguez, M Ruta, T Schulze, J Trevino, T Kunaratskul and G Soderberg (2023), “Geoeconomic Fragmentation and the Future of Multilateralism”, IMF Staff Discussion Note, SDN/2023/01.
Amiti, M, and D E Weinstein (2011), “Exports and Financial Shocks”, The Quarterly Journal of Economics 126(4): 1841–1877.
Baker, S R, N Bloom, and S J Davis (2016), “Measuring Economic Policy Uncertainty”, The Quarterly Journal of Economics 131(4): 1593–1636.
Bloom, N, P Bunn, S Chen, P Mizen, P Smietanka, and G Thwaites (2019), “The impact of Brexit on UK firms”, NBER Working Paper No 26218.
Bolhuis, M, J Chen, and B Kett (2023), “Fragmentation in Global Trade: Accounting for Commodities”, IMF Working Paper Working Paper 23/73.
Bonfim, D, and S Félix (2023), “Foreign-owned firms and bank distress”, IBRN - Banco de Portugal
Born, B, G J Müller, M Schularick, and P Sedláček, (2019), “The Costs of Economic Nationalism: Evidence from the Brexit Experiment”, Economic Journal 129(623): 2722-2744.
Buch, CM and L S Goldberg (2020), “Global Banking: Toward an Assessment of Benefits and Costs”, Annual Review of Financial Economics 12: 141-175.
Bush, G, Lara, J L and C López (2023), “Trade Policy Uncertainty and Domestic Credit: the Case of Mexico”, manuscript, Banco de México.
Cao, J, Dinger, V, Juelsrud, R E, Liaudinskas, K (2022) “Trade conflicts and credit supply spillovers : Evidence from the Nobel Peace Prize trade shock”, BOFIT Discussion Papers 8/2022.
Cetorelli, N, and L S Goldberg (2012), “Liquidity management of U.S. global banks: Internal capital markets in the great recession”, Journal of International Economics 88(2): 299–311.
Correa, R, J di Giovanni, L Goldberg, and C Minoiu (2022), “Trade Uncertainty and U.S. Bank Lending”, at SSRN.
Fajgelbaum, P and A Khandelwal (2021), “The Economic Impacts of the US-China Trade War”, NBER Working Paper No. 2931.
Federico, S, F Hassan, and V Rappoport (2020), Trade shocks and credit reallocation”, CEPR Discussion Paper No. 14792.
Federico, S, G Marinelli, and F Palazzo (2022), “The 2014 Russia shock and its effects on Italian firms and banks”, Bank of Italy Occasional Paper, forthcoming.
Haas, R De, and N Van Horen (2013), “Running for the Exit? International Bank Lending During a Financial Crisis”, The Review of Financial Studies 26(1): 244–285.
Imbierowicz, B, A Nagengast, E Prieto, and U Vogel (2023), “Bank Lending and Firm Internal Capital Markets following a Deglobalization Shock”, IBRN – Deutsche Bundesbank
Lloyd, S., Reinhardt, D and R Sowerbutts 2023 “Financial services trade restrictions and lending from an international financial centre”, Bank of England Working Paper No 1022.
Margaretic, P, and D Moreno (2023), “The trade tensions of 2016-18, trade finance, and spillover effects: A prelude to international fragmentation?”, manuscript, Banco Central de Chile.
Niepmann, F (2015), “Banking across borders", Journal of International Economics 96(2): 244–265.
Niepmann, F, and T Schmidt-Eisenlohr (2017), “International trade, risk and the role of banks”, Journal of International Economics 107: 111–126.
Pedrono, J (2022), “International trade and cross-border banking: a granular approach using bank specialization”, IBRN – Banque de France
Peek, J, and E S Rosengren (2000), “Collateral damage: Effects of the Japanese bank crisis on real activity in the United States”, American Economic Review 90(1): 30–45.
Schnabl, P (2012), “The international transmission of bank liquidity shocks: Evidence from an emerging market”, The Journal of Finance 67(3): 897–932.
Weinstein, D E, and M Amiti (2018), “How Much Do Idiosyncratic Bank Shocks Affect Investment? Evidence from Matched Bank-Firm Loan Data”, Journal of Political Economy 126(2): 525–587.
