Download → Financial services trade restrictions and lending from an international financial centre

Abstract

This paper examines how international lending of UK-based banks is affected by services trade restrictions on commercial banks applied abroad. Exploiting heterogeneity in banks’ cross-border activities, we find evidence that banks without a local affiliate presence abroad cut back their non-bank lending to countries applying restrictions, and vice versa when restrictions are liberalised. On the other hand, banks with a local presence reduce their intragroup loans, but substitute for this by increasing direct cross-border lending to non-banks. These findings suggest that increasing services trade restrictiveness may lead global banks to reshape their business model for cross-border lending. Services trade restrictions that act on the intensive margin of lending, such as barriers to competition, appear to be the primary drivers of this substitution from ‘local’ to ‘global’ financial intermediation.

1 Introduction

Over the last three decades, there has been a substantial increase in cross-border services trade. Between 2005 and 2017, trade in services expanded at an average rate of 5.4% per year—faster than the growth in goods trade (World Trade Organisation, 2019). A key component of this has been increases in cross-border financial flows, spurred by heightened financial market integration. According to latest estimates, financial-services trade comprises about one-fifth of overall global trade in services. However, for a few key international financial centres, where cross-border banking is particularly important, this figure is even larger. In the UK—a major international financial centre—foreign-owned branches and subsidiaries of commercial banking groups undertake their global activity in London (e.g. Beck, Lloyd, Reinhardt, and Sowerbutts, 2023). As a result, the cross-border claims of UK-based banks now totals over $5 trillion, having grown from around $2 trillion in 2000.

Despite the substantial increase in trade in services and commercial banks’ cross-border flows, restrictions on services trade remain pervasive. Many of these are non-tariff in nature, and tend to be somewhat tighter than for other services sectors. Restrictions on financial services trade have not shown a trend decline in past decades either. According to the OECD Services Trade Restrictiveness Index (STRI)—which we use in our empirical analysis in this paper—19 countries, out of 48 in the database, recorded commercial banking services-trade restrictions in 2020 that were less restrictive (looser) compared to their 2014 levels, while 19 countries had higher (tighter) restrictions.

These trends in services trade and services-trade restrictions stand in contrast to trade in goods. Bilateral and multilateral goods trade agreements have resulted in tariff reductions and contributed to a substantial increase in world goods trade (e.g. Baier and Bergstrand, 2007). Barriers to trade in services have not been liberalised to the same degree as barriers to trade in goods (e.g. Joy, Lisack, Lloyd, Reinhardt, Sajedi, and Whitaker, 2018), motivating our specific focus on services in this paper. Miroudot, Sauvage, and Shepherd (2013) estimate that, over the 1995-2005 period, effective trade costs for goods fell by around 15%, while those for services remained roughly constant.

However, services trade differs substantially from trade in goods. Many services tend to be intangible, so do not cross borders in a physical sense. As a result, the majority of servicestrade restrictions are in the form of non-tariff barriers—such as provision of licenses to operate. Trade in financial services, which we focus on here, can mainly be done in two differen ways: either by establishing a local presence where services are sold through a local subsidiary or branch—which can either be funded independently or via intragroup lending—or crossborder trade where financial services are provided directly from abroad. Each approach is subject to differing levels of restrictions and regulation. The UK is an ideal environment to study the effect of how changes in commercial banking restrictions affects financial-services lending. While the UK is a global centre for cross-border banking, many firms with a major UK presence also have a local presence, to differential degrees, in countries which have tightened or loosened services-trade restrictions.

In this paper we use the OECD STRI database for financial services (Rouzet, Nordas, Gon- ˚ zales, Grosso, Lejarraga, Miroudot, and Ueno ´ , 2014) and exploit the heterogeneity of UK-based banks’ global presence to examine how changes in services-trade restrictions on commercial banking in countries that receive inflows from UK-based banks affect the provision of international lending by UK-based banks. Services-trade restrictions in the commercial banking sector encompass restrictions on the entry by foreign affiliates, barriers to competition, regulatory (in)transparency, restrictions to the movement of people, and other discriminatory measures. They thus relate to restrictions which make it more difficult for foreign affiliates to operate domestically, but importantly do not include restrictions to the cross-border provision of financial services.

To structure our analysis, we focus on two potentially competing effects. On the one hand, a tightening (loosening) of services-trade restrictions for commercial banks could increase (decrease) the costs associated with ‘selling’ their banking activities to the country which tightened restrictions. For instance, tighter (looser) restrictions could increase (decrease) the fixed costs of entering a market or influence the transaction costs of extending new credit to the country. As such, tighter (looser) services-trade restrictions are likely to be associated with a lower (larger) supply of cross-border credit from UK-based banks to receiving countries through their effect on intermediation costs.

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By Simon Lloyd, Dennis Reinhardt and Rhiannon Sowerbutts