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Licensed Unlicensed Requires Authentication Published by De Gruyter February 19, 2020

Credibility, Reputation and De-Risking in Global Banking: Evidence from a Theoretical Model

Michael Brei, Lauren Cato and R. DeLisle Worrell

Abstract

This paper investigates the de-risking phenomenon from the perspective of an international bank’s decision to de-risk in a foreign market, where there is asymmetric information and costly monitoring. We consider three adverse shocks to a foreign affiliate’s (i) perceived credibility, (ii) costs of monitoring, and (iii) reputation, as reflected in a loss of franchise value. We show that the headquarters’ incentives to reduce international exposures are prompted by increasing funding and monitoring costs and by falling franchise values. Distortions arise because adverse credibility shocks make funding rates less responsive to actual risk choices, and impairments in the bank’s reputation negatively affect franchise values. All else equal, this reduces the bank’s incentives to retain and monitor the foreign affiliate, and risks increase. The risk effects are most pronounced in the case of credibility shocks, and incentives to reduce international exposures are strongest when reputational risks affect headquarters.

JEL Classification: F34; D82; G21

Acknowledgement

We would like to thank Ankie Scott-Joseph, Winston Moore and Alfredo Schclarek for helpful comments. We also thank the Editor, Martin Guzman, and two anonymous referees for valuable comments. Any remaining errors are our own.

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Published Online: 2020-02-19

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