Cross - Border Bank Flows and Systemic Risk

We examine the impact of cross-border bank flows on recipient countries’ systemic risk. Using data on bank flows from 26 source countries to 119 recipient countries, we find that bank flows are associated with improved financial stability (i.e. lower systemic risk) in the recipient country. The impact of bank flows is stronger in recipient countries with weak regulatory quality and fragile banking sectors; weak evidence suggests that the impact is more pronounced when bank flows come from source countries with relatively stronger regulatory quality and more stable banking sectors. In addition, we document that bank flows reduce systemic risk of larger banks, with poor asset quality and more volatile sources of funds. The evidence suggests that bank flows reduce systemic risk by improving banks’ aggregate funding mix and by reducing reliance on non-traditional revenue sources for banks domiciled in fragile countries. Overall, our evidence supports the benign view of regulatory arbitrage in international bank flows.