Le Pont de Londres: Interactions between monetary and prudential policies in cross‐border lending

Abstract

We examine how euro area (EA) monetary policy and recipient-country prudential policy interact to influence cross-border lending of French banks. We find that monetary spillovers via cross-border lending can be partially offset by prudential measures in receiving countries. We then explore heterogeneities, specifically by bank size and location of the affiliate (French HQ vs. affiliates based in the UK). We find that the response of lending from French HQ to EA monetary policy is less sensitive to recipient-country prudential policy for systemic banks (GSIBs) than for non-GSIBs'. In contrast, the response of lending from GSIBs' affiliates in the UK is sensitive to recipient-country prudential policy. French GSIBs' crossborder lending from French HQ responds differently than lending from international financial centres. We also find evidence that French GSIBs channel funds towards the UK in response to EA monetary policy, in a manner dampened by global prudential policy setting. These findings suggest the existence of a 'London Bridge': conditional on EA monetary policy, French GSIBs adjust their funds in the UK depending on global prudential policies and, from there, lend to third-party countries according to local prudential policies. Finally, we have similar findings for all EA-owned banks UK affiliates, suggesting a broader relevance for the London Bridge.

Understanding Monetary Spillovers in Highly Integrated Regions: The Case of Europe*

“…(2021) also provide evidence that a monetary tightening re‐allocates cross‐border flows to countries that are deemed less risky. A small but growing literature relates cross‐border bank flows to macro‐prudential policies (Bussiere et al ., 2021; Takáts and Temesvary, 2021). Bussiere et al .…”

“…Correa et al (2021) also provide evidence that a monetary tightening re-allocates cross-border flows to countries that are deemed less risky. A small but growing literature relates cross-border bank flows to macro-prudential policies (Bussiere et al, 2021;Takáts and Temesvary, 2021). Bussiere et al (2021) show that countries with a tighter macro-prudential stance face a smaller decline in cross-border bank lending after a monetary tightening in the sending economy.…”

“…A small but growing literature relates cross-border bank flows to macro-prudential policies (Bussiere et al, 2021;Takáts and Temesvary, 2021). Bussiere et al (2021) show that countries with a tighter macro-prudential stance face a smaller decline in cross-border bank lending after a monetary tightening in the sending economy. Finally, Georgiadis and Zhu (2021) investigate the role of movements in the exchange rate in case of foreign currency lending.…”