Non-technical summary

Research Question

The pace of globalization has slowed since the global financial crisis, and recent events have sparked fears of a more widespread deglobalization and market fragmentation. This paper aims to better understand the effects of deglobalization events in a globalized world, and the role that financial and economic integration play in this regard. We explore how an event implying a turn towards deglobalization affects a highly integrated economy as well as other economies, which are economically and financially connected.

Contribution

We use the unexpected outcome of the Brexit referendum in June 2016, a major deglobalization shock of the last decade, and investigate its impact on bank credit supply, international spillovers, and real economic outcomes. Leveraging a unique dataset that combines a credit register with foreign direct investment (FDI) data, we are able to observe both domestic and cross-border credit exposures of German banks as well as internal capital market dynamics within multinational corporations (MNCs) – a feature rarely available in other countries’ data. Our analysis consists of three parts. First, we investigate the effect of the deglobalization shock on cross-border bank lending. In the second part of our analysis, we investigate whether the credit supply shock amplifies the deglobalization shock’s immediate adverse effects to the real economy and the role of firms’ internal capital markets. In the last part of our analysis, we investigate whether banks shift their lending to borrowers outside the UK after the shock.

Results

German banks reduced lending to United Kingdom (UK) firms following the shock due to increased uncertainty about future losses. More prudent banks reduced their credit more extensively, and less profitable subsidiaries experienced greater reductions. However, UK subsidiaries of large MNCs, with access to internal capital markets, offset this credit supply shock through internal funding, shielding them from negative real effects. We find that non-UK subsidiaries play a crucial role in internal capital markets by securing external financing and reallocating funds to support UK affiliates. Well capitalized banks reallocated lending to firms outside the UK, particularly those of German MNCs. Our findings underscore that while international financial frictions following deglobalization shocks can imply negative real effects, firms integrated into global networks mitigate these impacts through internal capital markets.