Macroprudential Regulation of International Finance

Macroprudential Regulation of International Finance

Managing Capital Flows and Exchange Rates

KDI/EWC series on Economic Policy

Edited by Dongsoo Kang and Andrew Mason

Recent events, such as capital flow reversals and banking sector crises, have shaken faith in the widely held belief in the benefits of greater financial integration and financial deepening, which are typical in advanced economies. This book shows that emerging economies have often weathered the storm best despite the supposed burden of ‘weak institutions’. It demonstrates that a better policy framework requires reliable indicators of vulnerability to financial instability, as well as improved policy tools and automatic stabilizers that anticipate and limit the vulnerabilities to financial crises.

Chapter 9: Investment patterns of foreign bank branches in Korea and their role in the foreign exchange market

Dongsoo Kang and Daehee Jeong

Subjects: asian studies, asian economics, economics and finance, asian economics, financial economics and regulation


The positive effects of foreign bank establishments have long been supported in much economic literature. Prior to the 2008 global financial crisis, a number of researchers stressed the enhanced efficiency and competitiveness of the domestic banking sector as a result of foreign bank entry (Moreno and Villar, 2005; Cull and Peria, 2010). Foreign bank entry is also reported to contribute to the stability of domestic credit markets (Dages et al., 2000; Arena et al., 2006). While domestic banks are forced to reduce lending during financial turmoil, foreign bank affiliates supported by their parent banks can alleviate the financing gap. Indeed, according to some observations, foreign bank lending was more stable than domestic bank lending during the East Asian financial crisis in the late 1990s (Montgomery, 2003). The European fiscal debt crisis in 2011, however, ignited a debate about the role of foreign bank entry in emerging economies. Although Cetorelli and Goldberg (2011) find only insignificant evidence that openness to international banking flows caused the propagation of the financial crisis even after the 2008 crisis, De Haas and Van Lelyveld (2011) raise the concern that multinational banks may increase the risk of importing instability from abroad. Popov and Udell (2010) find that during the 2007–08 financial crisis, multinational bank subsidiaries in Central and Eastern European countries cut lending to local small-and medium-size enterprises more than domestic banks did, especially when their parent banks were financially weak. Suh and Kim (2009) point out that the currency and maturity mismatches, led by foreign affiliates to obtain arbitrage incentives, threatened domestic financial stability in Korea.

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