Seven Decades of International Banking
In the seven decades since World War II, how has international banking changed and evolved to the present day?
A new journal article by Non-Resident Senior Fellow Robert N. McCauley, Patrick McGuire and Philip Wooldridge explores the structural and cyclical factors behind the international banking industry, including its evolution in the 1950s, the role of regulatory arbitrage and financial innovation and policymakers’ responses to the challenges posed by international banking.
From the ashes of the Second World War, international banking re-emerged in the 1950s. In 1963, when the Bank for International Settlements (BIS) started to collect data, banks’ outstanding international claims amounted to less than 2 percent of world gross domestic product (GDP). They grew rapidly in the following decades, peaking above 60 percent in 2007 before retreating to near 40 percent in early 2021. As the market expanded, the early predominance of interbank activity in a few major currencies gave way to business with non-bank financial and non-financial counter-parties in a multitude of currencies.
The authors found that regulatory arbitrage, financial innovation and financial liberalization were key drivers of international banking’s reemergence. Regulations that raised the costs of domestic intermediation made it attractive for banks to borrow and lend abroad. The development of new financial products, including syndicated loans and derivatives, altered the way banks manage risks in their international portfolios. According to the study, the transition of the broader international financial system from a tightly managed one with extensive exchange controls and capital account restrictions to today’s market-driven, integrated system was both a cause and a symptom of international banking’s growth.
Key takeaways:
- International banking since the 1950s has taken place mainly offshore, where lenders and borrowers transact in currencies foreign to them both.
- Regulatory arbitrage, financial liberalization and financial innovation drove a multi-decade expansion of international banking, which peaked at over 60 percent of world GDP on the eve of the Great Financial Crisis.
- Competition among banks for market share contributed to surges in international lending that amplified credit booms preceding major financial crises.
- Losses during the Great Financial Crisis, and regulatory reforms in its wake, constrained banks’ expansion and accelerated the rise of non-bank financial institutions as international creditors.