Loans from My Neighbors: East Asian Commercial Banks, Banking Integration, and Bank Default Risk

Abstract This study investigates the impact of financial integration on recipient country bank default risk and, in particular, if that relationship is moderated by the type of financial integration. Using the system generalized method of moments (GMM), the study finds that financial integration lowers bank default risk in the recipient countries. The impact is primarily driven by the foreign claims extended by Asian lenders and the foreign claims extended via local affiliates. These results show that the close proximity of lenders and borrowers or ‘local’ knowledge via an affiliate presence alleviates information asymmetry, allowing for effective monitoring and disciplining of the loan relationship. The result supports the fostering of financial integration, promoting deeper intra-regional connectedness throughout East Asia. When foreign claims come from outside East Asia, policy makers should encourage presence through local affiliates, as this has an equivalent impact.