“Global Banks and International Transmission of Financial Shocks”
Abstract: This paper analyses the role of global banks in international transmission of shocks when countries have different domestic financial market structures. In particular, capital requirement faced by a global bank and the level of financial development, i.e. share of investments financed by bank lending, vary across countries. A positive productivity shock in one country brings about an increase in its GDP with negative international spillovers, dynamics of which are independent of the financial conditions in the country of the shock. In contrast, it has global implications whether the country that is hit by a financial shock is more financially developed than the other or not. A financial shock in the more financially developed economy leads to a more severe global downturn than a similar shock in the less financially developed economy. Moreover, how fast a country recovers from a financial crisis depends on its degree of financial development and the bank capital regulations: although GDP declines simultaneously in both countries, the recession lasts shorter in the country with lower financial development and lower bank capital requirement.