Over the previous generation, there has been a drastic reduction in global barriers to competition in financial services, including the banking industry. Deregulation around the world and improvements in information technology have facilitated consolidation across distant and different types of banks in numerous countries around the world. In addition, growth in the cross-border activities of non-financial companies has catalysed a stronger demand for banking services. As a result, banking has become more globalised and growth in a bank’s foreign claims has outpaced that of economic activity.
As banking in most countries has become more globalised, the need to understand the role of bank globalisation has increased. In general, it is claimed that banking globalisation not only provides more access to liquidity and boosts lending activity but also encourages efficiency improvements in domestic banks. Structure conduct performance hypothesis supports this positive role of global banking, arguing that global banking stimulates competition, which in turn enhances efficiency.
On the other hand, the global financial crisis in 2008 bore witness to a more sinister side of banking globalisation, namely the international transmission of shocks and cycles. This more nefarious role of banking globalisation is supported by Mishkin (2009), Goldberg (2009), Cetorelli and Goldberg (2008, 2009), Garcia- Herrero and Martinez Peria (2007).
Mishkin (2009) argues that if financial globalisation is not managed properly it will lead to financial crises that trigger wide spread economic hardship. Mishkin (2009) added that ensuring financial globalisation works well is not a simple task; it requires policies that promote property rights and good-quality financial information, encourage effective prudential supervision, and promote a stable macroeconomic environment. According to Mishkin (2009), policies concerning financial globalisation should be homegrown. Nevertheless, international financial institutions such as the International Monetary Fund and the World Bank can create incentives to promote these policies in emerging market economies. Citizens in advanced countries can also help by supporting the opening up of their markets to goods and services from poorer economies, thereby encouraging expansion of their export sectors, which creates increased support for financial development and less vulnerability to financial crises.
In line with Mishkin, Goldberg (2009) argues that global banks play a significant role in the transmission of shocks through their activities, contributing to a more integrated global business cycle. According to Goldberg (2009), the most recent global financial crisis is clear evidence of the role played by global banks in the international transmission of shocks.
Cetorelli and Goldberg (2008) support the argument regarding the potential role global banks play in the international transmission of shocks with their finding that capital flows to emerging market regions declined dramatically during the global financial crisis, and concomitantly there was a significant decline in internal lending from the parent and other overseas affiliates to foreign-owned banks in emerging markets. In further analyses, Cetorelli and Goldberg (2009) indicate that lending supply in emerging markets was affected through separate channels: a contraction in direct, cross-border lending by foreign banks, a contraction in local lending by foreign banks’ affiliates in emerging markets, and a contraction in lending supply by domestic banks, as a result of the funding shock to their balance sheets induced by the decline in interbank or cross-border lending.
Garcia-Herrero and Martinez Peria (2007), focusing on stability, lend support to the argument concerning the role of global banks in the transmission of shocks during a crisis. Based on their analysis of Latin American cases, Garcia-Herrero
and Martinez Peria (2007) found that cross-border lending by global banks is less stable compared to local lending by global bank branches and subsidiaries. Cross-border lending diminishes during economic slowdowns, whereas local lending by foreign banks appeared to be much more stable. This finding is congruous with research conducted by Peek and Rosengren (2000). According to Peek and Rosengren (2000), reductions in cross-border lending were generally met by increases in lending by foreign bank subsidiaries, either because new subsidiaries were established or because the lending of the existing affiliates increased.
A large number of studies report similar findings that cross-border bank lending tends to be less stable compared to local bank lending (Goldberg, Dages and Kinney (2000), Detragiache and Gupta (2006), de Haas and van Lelyveld (2006)).
Regarding the case of Indonesia, it is generally agreed that the domestic banking industry has become more globalised. Abdullah (2010), using foreign claims data from BIS, found that the Indonesian banking industry has become more open and integrated with global banks since banking liberalisation in the late 1980s. According to Abdullah (2010), in the case of Indonesia, tighter integration with global banks has not led to greater competitiveness and efficiency. In fact, compared to other ASEAN economies, the banking industry in Indonesia is the least competitive.
Parallel to Abdullah’s findings, Hui (2009) reported that between 1991 and 1996 some US$41 billion in net investments flowed into Indonesia compared to US$15 billion in the preceding six years. This deluge was in the form of bank loans that bloated the banking sector. The ratio of total bank assets to GDP rose from 35% in 1985 to 114% in 1997. This huge surge in liquidity created opportunities to expand economic activities and as a result the Indonesian economy grew rapidly at an average of 7-8% per annum. The torrent of bank loans, however, intoxicated lenders and borrowers alike, and resulted in poor credit discipline on the part of the lenders and financial mismanagement on the part of the borrowers. Lenders lent more than what the borrowers required. Borrowers, for their part, inflated their project costs and siphoned off excess money into their own pockets. This resulted in a frail Indonesian banking system that ultimately collapsed when the financial crisis befell Indonesia.
Abdullah (2010) and Hui’s findings (2009) confirm that global banks in Indonesia have played a positive role in providing liquidity to expedite economic growth. In addition, the findings also prove that the efficiency hypothesis does
not hold true in the case of Indonesia. However, the role played by global banks in international shock transmission is not discussed.
3. The Role of Global Banks in the Indonesian Economy: Trend Analysis