Internal Capital Markets in Multinational Banks: Implications for European Transition Economies

Abstract

We use focused interviews with bank managers to analyse how multinational banks use internal capital markets to control their subsidiaries. It is found that foreign bank affiliates are strongly influenced by the capital allocation and credit steering mechanisms of the parent bank. Parent banks generally set credit growth targets, which may then be supported by book capital and debt funding. This passive approach establishes a minimum amount of local book capital and is driven by regulatory considerations. In addition, some banks have started to use semi-active economic capital models. By charging subsidiaries for the use of economic capital, parent banks introduce a constraint at the individual loan level. This bottom-up approach determines the pace at which subsidiaries are able to meet their credit growth targets. Our findings suggest that the credit growth of subsidiaries may critically depend on the financial position of the parent bank.

Keywords: Foreign banks, transition economies, internal capital markets

JEL Classification: F23, F36, G21, G31, G32