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International Transmission of Shocks via Internal Capital Markets of Multinational Banks: Evidence from South Africa

30.11.2015Adeline Pelletier, Assistant Professor, Instituto de Empresa

It is well documented that global banks contribute to international shock transmission via cross-border lending. Yet, global banking has taken another form over the recent decades with the expansion of banks abroad via branches and subsidiaries. This expansion has especially happened from and to developing and emerging economies, as countries have opened up their banking sector to foreign investors (Claessens and van Horen, 2012).

Multinational banks operate internal capital markets through which they (re-)allocate capital between their headquarters and their different foreign affiliates in response to financial or real economic shocks. In developing countries where interbank and capital markets are underdeveloped and a large part of the population is unbanked, the ability to receive funding through internal capital markets at low cost and in large quantity might present a significant advantage for foreign banks' affiliates. However, as internal funding reallocation can alter the funding position of a bank's affiliate, this may in turn lead to adjustments in foreign affiliates lending in their host market, thus creating another channel of international transmission of shocks (Cetorelli and Goldberg, 2012).

Impact of a financial crisis on capital re-allocation inside banking groups

In a recent study, I explore this issue by using a novel database on banks operating in South Africa, which includes information on internal loans and deposits from and to the banking group.

In exploring the impact of the 1997 East Asian Crisis on capital re-allocation inside banks, I found that that South African affiliates belonging to banking groups with high exposure to East Asian Crisis countries (in terms of total banking assets of the group in crisis countries) experienced a significant drop in their net internal funding position during the crisis, relative to South African affiliates of less exposed groups. The South African foreign affiliates of highly exposed multinational banks both received less internal funding from their group during the East Asian Crisis period than before, and lent more to their group, relative to the affiliates of less exposed groups. This result suggests that parent banks of more exposed groups reallocated capital away from South Africa to support their affiliates in east Asia.

Exploring the link between internal capital funding and domestic lending

Do foreign affiliates that receive internal capital from their group expand their local bank credit? Using an instrumental variable technique, I found that a 10% increase in the outstanding volume of internal funding resulted in a 5.6% increase in the volume of mortgage advances. As such, foreign affiliates do not only use this extra capital to acquire government securities or to invest abroad, as it has been reported in Africa where banks are often highly liquid but lend relatively little domestically (see Beck, Maimbo, Faye and Triki, 2011).They also "pass it on'' to the local economy by expanding their domestic lending.

Policy implications

This study suggests that foreign affiliates have ambiguous effects for the financial stability of the host country. On the one hand, being part of a foreign group reduces the risk of bankruptcy of foreign affiliates by allowing for the reception of internal capital from the group.

On the other hand, internal capital markets are a channel through which financial crises are transmitted from one country to another, when abrupt capital reallocations inside the group take place. However, the strength of this channel will partly depend on the legal structure of the foreign affiliate. Indeed, the organisational form of the foreign affiliate, either as a branch or as a subsidiary will have an impact on the stability of the banking sector and the local supply of credit through the internal capital market channel, as branches are more integrated to their group via this channel than subsidiaries.

A potential policy implication of this research for bank regulators may be that favouring organisation of foreign affiliates as subsidiaries rather than branches, through specific banking regulations, may reduce the potential transmission of foreign crises via internal capital markets. One caveat, however, is that if a banking crisis occurs in the host country, a parent is fully responsible for all losses incurred under a branch structure. Under a subsidiary structure, a parent's obligations are only limited to the value of the invested equity, which makes it more likely to walk away from the operation (Cerrutti et al., 2007; Fiechter et al., 2011). That said, if a foreign affiliate has systemic importance for the health of the banking group, its parent is more likely to support it through transfers of internal liquidity, regardless of its organisational form.


Beck, Thorsten, Samuel Maimbo, Issa Faye, and Thouraya Triki. 2011. Financing Africa: Through the crisis and beyond. Washington DC: World Bank.

Cerutti, Eugenio, Giovanni Dell'Ariccia, and Maria Soledad Martinez Peria. 2007. “How banks go abroad: Branches or subsidiaries?” Journal of Banking and Finance 31 (6):1669-1692.

Cetorelli, Nicola and Linda 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.

Claessens, Stijn and Neeltje Van Horen. 2012. “Foreign Banks: Trends, Impact and Financial Stability.” Working Paper WP/12/10, IMF.

Fiechter, Jonathan, Inci Otker-Robe, Anna Ilyina, Hsu Michael, Andre Santos, and Jay Surti. 2011. “Subsidiaries or Branches: Does One Size Fit All?” IMF Staff Discussion Note SDN/11/0, IMF.


This blog post is based on the MFW4A Working Paper Series "Internal capital market practices of multinational banks: Evidence from South Africa".

Adeline Pelletier is an assistant professor at IE. She was previously a postdoctoral researcher affiliated to the Centre for Economic Performance at the London School of Economics, researching mobile payment services for the unbanked. She obtained her PhD in Business Economics from the London School of Economics in 2014, with a thesis on the performance, corporate financial strategy and organization of multinational banks in Africa. Prior to her doctoral studies she completed a MPhil in Development Studies at the University of Cambridge (2011) and she also holds a MPhil in Economics from Sciences-Po Paris (2006).

Are Anti–Money Laundering Policies Hurting Poor Countries? – New CGD Working Group Report

30.11.2015Clay Lowery and Vijaya Ramachandran, Center for Global Development

In 2009, G-8 Leaders set a goal of reducing remittance costs to 5 percent within 5 years, roughly a 5 percentage point decrease. Instead, the cost of sending remittances from G-20 countries to "high risk" countries has stayed almost flat, and to "less risky" countries, has decreased slightly more than 1 percentage point.

Last month, the Financial Stability Board (FSB) - which coordinates and reviews the work of the international standard setting bodies in the area of financial regulation - published a report to the G-20 stating that in a survey carried out by the World Bank, roughly half of emerging market and developing economies have experienced a decline in correspondent banking services, which allows for banks to make and receive international payments.

In other words, despite the laudable G-20 policy goal of achieving more inclusive economic growth, there appears to be a disturbing trend of banking services declining or, at least, not becoming more cost effective for some countries. Why do we see these trends in remittance costs and correspondent banking relationships? A new CGD report - the outcome of a working group of policymakers, academics and individuals from the private sector - says that one reason (and we emphasize that it is not the only driver) might be that these trends are the unintended consequences of anti-money laundering / combating the financing of terror (AML/CFT) policies in rich countries.

Under current AML/CFT rules, banks are asked to prevent sanctions violations and assess and mitigate money laundering and terrorist financing risks, or face penalties. However, regulators sometimes send mixed signals about whether and how banks and other entities should manage these risks, which can result in simplistic risk assessment methodologies being applied by these entities. There may also be a chilling effect resulting from the imposition of legitimate fines on some large banks for egregious contraventions of AML/CFT rules and, particularly, sanctions laws. These factors, along with others, have led banks to adopt an understandably conservative position. This includes exiting from providing services to firms, market segments and countries that are seen as higher risk, including money transmitters, banks in poor countries and non-profit organizations.

Let us illustrate our findings with an example. In 2013, Barclays closed the accounts of nearly 90% of its UK-based money transfer organizations. It was the last large bank in the country willing to provide accounts to the money remitters that are a lifeline for migrants trying to send funds to families in poor countries. This wasn't the first time that a bank decided to withdraw nearly wholesale from the remittances sector - a process known as 'de-risking' (see Figure 1). Nor will it be the last.

At a time when remittances are worth more than three times total foreign aid flows, these kinds of actions could have a significant impact on individuals - and entire countries. It's not just migrant worker families that suffer from 'financial abandonment.' As stated earlier, banks in poor countries find themselves cut off from correspondent banking services: trade finance, clearing and settlement, cash management, and international wire transfers; while non-profit organizations (NPOs) are often unable to obtain banking services thereby hampering their work, especially those NPOs associated with 'high risk' areas that are often home to the world's poorest and most vulnerable people.

Figure 1: The Widespread De-Banking of Remittance Providers

Such unintended consequences are causing concern at the highest levels: both Federal Reserve Chairwoman Janet Yellen and Bank of England Governor and Financial Stability Board Chairman Mark Carney acknowledge the very real problems of de-risking. Standards setters, such as the Financial Action Task Force (FATF, the global standard setting body for AML/CFT), and regulators have acknowledged the existence of de-risking and are starting to work to address it. In the meantime, the losers are manifold.

Who are the losers?

  • Migrant workers and their families. For the remittance system to work effectively there must be a healthy money transfer sector. Money transfer organizations (MTOs) are seeing banking services denied, downgraded, or made more expensive. In other words, MTOs are pushed out of one bank and have to find another that may be more expensive, or based in a less transparent jurisdiction. This leaves only larger money transfer organizations with access to bank accounts, which can raise the cost of sending remittances. Industry bodies report that many smaller players have been forced to close, become agents of larger businesses, or even disguise the true nature of their operations in order to remain banked. Given that remittances from migrant workers total $440bn a year, a vital source of finance for poor countries might be affected.
  • People in post-disaster or conflict situations. Vulnerable people in post-disaster or conflict situations rely on non-profit organizations to deliver humanitarian assistance. However, NPOs are reporting difficulties in carrying out operations. For instance, HSBC closed the bank account of several NPOs including the Cordoba Foundation, a think tank that receives money from the UK government for work to prevent terrorism, saying only that continuing to bank the organization 'fell outside the bank's risk appetite'.
  • Small to medium-sized firms. These enterprises are crucial to the economy in poor countries but they often lack the credit they need to conduct operations, grow their businesses, and create jobs. To get access to this credit, they often need local banks to have the ability to conduct cross-border transactions to make and receive international payments. Unfortunately, developed country banks increasingly report withdrawing correspondent banking services from banks in high-risk jurisdictions, including many poor countries, reducing their access to the global financial system.
  • People in rich and poor countries alike. Public safety and economic stability in both rich and poor countries rely on financial regulators and law enforcement having visibility of transactions. However, such agencies increasingly find it difficult to track transactions. This is because MTOs who cannot send funds electronically begin to use potentially less transparent mechanisms like bulk currency exchanges. Transparency is also reduced when banks and businesses in poor countries have to send funds via banks operating in less transparent jurisdictions.

What can be done?

Our report puts forward five recommendations that would require action by national regulators, international standard setters, international organizations, and private institutions to work toward a solution. These are the first steps that must be taken toward solving the problem:

  1. Rigorously assess the unintended consequences of AML/CFT and sanctions enforcement at the national and the global level. The strength of the suggestive evidence detailed in the report requires a rigorous causal investigation of the unintended consequences of AML/CFT conducted by the relevant international institutions as specified in the report.
  2. Generate better data and share existing data between institutions. In order to assess unintended consequences rigorously, more and better data should be generated through private and public sector efforts that we elaborate upon in the report.
  3. Strengthen the risk-based approach. FATF should be congratulated for introducing and recently strengthening its risk-based approach. However, it needs to be implemented more extensively and more consistently.
  4. Improve compliance and clarify indicators of lower risk. Compliance procedures at many NPOs and MTOs must be improved so as to be more effective. At the same time, more needs to be done to recognize those NPOs and MTOs that do have effective systems in place, including better supervision of MTO sectors at the country level.
  5. Facilitate identification and lower the costs of compliance. National governments, banks and the World Bank should accelerate the adoption of new and existing technology such as Legal Entity Identifiers and biometric ID to facilitate lower cost customer identification, and enable "know your customer" compliance and due diligence while still protecting individual privacy.


This post was originally published on the Center for Global Development website. 

Clay Lowery is a visiting fellow at CDG. He currently serves as Vice President for Rock Creek Global Advisors, an international advisory firm that assists clients to anticipate and seize opportunities in the global marketplace, while mitigating political and regulatory risk. 

Vijaya Ramachandran is a senior fellow at the Center for Global Development. She works on private sector development, financial flows, food security, humanitarian assistance and development interventions in fragile states.

International Remittances and Financial Inclusion in Sub-Saharan Africa

29.09.2014Maria Soledad Martinez Peria

Remittances to Sub-Saharan Africa (SSA) have increased steadily in recent decades and are estimated to have reached about $32 billion in 2013. Though studies have shown that remittances can affect aggregate financial development in SSA - as measured by the share of deposits or M2 to GDP (Gupta et al. 2009), to my knowledge there is no evidence for this region on the impact of remittances on household financial inclusion defined as the use of financial services. This question is important because there is growing evidence that financial inclusion can have significant beneficial effects for households and individuals. In particular, the literature has found that providing individuals access to savings instruments increases savings, female empowerment, productive investment, and consumption. Furthermore, the topic of financial inclusion has gained importance among international bodies. In May 2013, the UN High-Level Panel presented the recommendations for post-2015 UN Development Goals, which included universal access to financial services as a critical enabler for job creation and equitable growth. In September 2013, the G20 reaffirmed its commitment to financial inclusion as part of its development agenda.

In a recent paper, my co-author, Gemechu Ayana Aga and I explore the link between international remittances and one aspect of financial inclusion in SSA: households' use of bank accounts [1]. This issue is particularly important for SSA, given that on average only 24 percent of the population has an account with a formal financial institution. In contrast, 55 percent of adults in East Asia, 35 percent in Eastern Europe, 39 percent in Latin America, and 33 percent in South Asia have accounts.

Remittances may affect households' use of bank accounts in at least two ways. First, remittances might increase the demand for savings instruments. The fixed costs of sending remittances make the flows lumpy, potentially providing households with excess cash for some period of time. This might increase their demands for deposit accounts, since financial institutions offer households a safe place to store this temporary excess cash. Second, remittances recipients' exposure to banks, for example, when banks act as remittances paying agents, may familiarize them with the services offered by banks and increase their demand for bank accounts. Therefore, so long as lack of awareness is the main reason for households' financial exclusion, remittances may increase households' use of bank accounts.

Using World Bank survey data including about 10,000 households in five countries -- Burkina Faso, Kenya, Nigeria, Senegal and Uganda - we find that receiving international remittances increases the probability that the household opens a bank account in all the countries in our study. This result is robust to controlling for the potential endogeneity of remittances, using as instruments indicators of the migrants' economic conditions in the destination countries.

The size of the impact varies across countries (see Figure 1). In Kenya and Nigeria, receiving international remittances increases the probability of a household having a bank account by about 10 percentage points. The size of the coefficient is larger for Uganda, where receiving international remittances increases the probability of having a bank account by about 15 percentage points. The size of the coefficient is smaller for Senegal and Burkina Faso, where receiving international remittances increases the likelihood of having a bank account by about 5 and 6 percentage points, respectively.

Figure 1: The impact of remittances on the likelihood that households own a bank account



Want to know more about the remittances of migrants from the perspective of a local user? Read this very interesting article about a taxi driver from the Togolese diaspora. 

Maria Soledad Martinez Peria is the Research Manager of the Finance and Private Sector Development team of the Development Economics Research Group at The World Bank. Prior to joining The World Bank, Sole worked at the Brooking Institution, the Central Bank of Argentina, the Federal Reserve Board and the International Monetary Fund.


[1] Ayana Aga, Gemechu and Maria Soledad Martinez Peria, 2014. "International Remittances and Financial Inclusion in Sub-Saharan Africa." World Bank Policy Research Working Paper 6991.


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