Skip to main content
SpringerLink
Log in

The UK’s banking FDI flows and Total British FDI: a dynamic BREXIT analysis

  • Original Paper
  • Published:
International Economics and Economic Policy Aims and scope Submit manuscript

Abstract

The City of London has been the global leader for the provision of international banking services since the 1980s when Thatcher-era deregulation, followed by the EU single market program, stimulated big international FDI inflows – mainly of US banks – into the UK. The “single passport” rule allowed international banks in the UK to serve the whole of the EU28 market from London whose supply-side dynamics contributed to economic growth in the UK and a rising output share of the UK banking system in British GDP. With the expected BREXIT, there are serious challenges for the City since the passporting of banks will end and the regulatory framework will be adjusted; EU equivalence rules for UK banks that might be valid after the implementation of BREXIT cannot be a substitute for passporting so that lower FDI inflows and higher FDI outflows in the banking sector should be expected; inflow dynamics should also be shaped by international M&A dynamics influenced by the real Pound depreciation in 2016, while the prospects of reduced EU market access post-BREXIT also became relevant in 2017/18 and should influence the FDI dynamics of the UK – a similar pattern might occur in the BREXIT implementation year (i.e. 2019) and the following adjustment period where the change in City banks’ access to the single market will matter; as regards the latter, quasi-tariff-jumping FDI outflows from the UK can be expected where the FDI of City of London banks could go primarily to the EU27/Eurozone or the US. The empirical findings confirm the expected FDI pattern for the UK banking sector – overall FDI inflows in the wake of the BREXIT referendum have increased, in line with the Froot-Stein effect, while FDI inflows to the UK banking sector have declined.

This is a preview of subscription content, log in via an institution to check access.

Access this article

Log in via an institution

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Instant access to the full article PDF.

Institutional subscriptions

Fig. 1
Fig. 2
Fig. 3

Similar content being viewed by others

Notes

  1. Exports from country i to country j depend on trade costs across all possible export markets (outward resistance); imports into country i from country j depend on trade costs across all possible import markets (inward resistance).

  2. The farther away an investment is, the more difficult it is to anticipate correctly changes and developments in investments; this might be linked to economic and cultural differences, but also, for example, to something as seemingly innocuous as different time zones.

  3. Collecting information about clients and customers is increasingly costly over greater distances.

  4. A substantial number of papers also use data on external claims by banks from the BIS. Some recent papers that have estimated empirical gravity equations for equity, bond and bank holdings include Ahearne et al. (2004), Aviat and Coeurdacier (2007), Balli (2008), Balli et al. (2008), Balta and Delgado (2008), Berkel (2007), Bertaut and Kole (2004), Buch (2005, 2002), Chan et al. (2005), Coeurdacier and Martin (2009), Coeurdacier and Guibaud (2005), Daude and Fratzscher (2008), de Santis and Gerard (2009), Eichengreen and Luengnaruemitchai (2006), Faruqee et al. (2004), Forbes (2008), Gande et al. (2009), Garcia-Herrero et al. (2009), Gelos and Wei (2005), Ghosh and Wolf (2000), Hahm and Shin (2009), Jeanneau and Micu (2002), Kim et al. (2006), Kim et al. (2007), Lane and Milesi-Ferretti (2005, 2008), Lane (2005), Martin and Rey (2004), Pendle (2007), Portes and Rey (2005), Portes et al. (2001), Rose and Spiegel (2004), Salins and Benassy-Quere (2006), Vlachos (2004) and Yu (2009).

  5. A detailed listing and definition of assets/liabilities/claims can be found on the website of the Deutsche Bundesbank:https://www.bundesbank.de/resource/blob/611438/f16d975bfe10fc0baba76e984b1cdac4/mL/statso-1-05-auslandstatus-banken-data.pdf pp. 263–268

  6. Some central banks are reticent for reasons of banking secrecy; mainly due to tax avoidance strategies and competitive advantages between countries and their banking sectors. The Bank of England, for example, is one of the central banks who do not report their total linkages to all foreign countries and banks.

  7. Country list of UK partners: Austria, Australia, Belgium, Brazil, Canada, Switzerland, Chile, Germany, Denmark, Spain, Finland, France, Guernsey, Greece, Hong Kong SAR, Ireland, Isle of Man, Italy, Jersey, Japan, Korea, Luxembourg, Macao SAR, Mexico, Netherlands, Philippines, Sweden, Chinese Taipei, United States, South Africa.

  8. In September 2018, German banks reported holding €233 million in foreign coins and banknotes in contrast to €1,855,669 million in other assets. Source: Balance sheet statistics of German banks, September 2018, Deutsche Bundesbank.

  9. Note that models (4)–(9) represent robustness checks for asset inflow to the UK, including exchange rates and controlling for the Euro Area instead of EU membership

  10. For robustness, we check the model with exchange rates on an annual (not quarterly) basis in order not to interfere with time FE; we use annual data for the period 1977–2016 from the Federal Reserve Bank of St. Louis, for 2017/2018 averaged daily data from the Bank of England, where for 2018 we average the first quarter only; see Table 3 (in Appendix).

  11. The Breitung unit root test, Hadri Lagrange multiplier stationarity test, and Im-Pesaran-Shin unit root test show significant P-values indicating stationarity, while Levin-Lin-Chu and Fisher unit root tests show insignificant values; we follow Fidrmuc (2008) and transfer his findings on OLS to PPML stating that our fixed effects take into account potential non-stationarity.

  12. We use the FRED real foreign exchange rate index; decreasing numbers mean weaker BPS and stronger USD.

  13. Adding exchange rates in model (5) leaves results unchanged.

Abbreviations

US:

United States

FDI:

Foreign Direct Investment

UK:

United Kingdom

GDP:

Gross Domestic Product

EU:

European Union

M&A:

Mergers & Acquisitions

ESRB:

European Systemic Risk Board

EBA:

European Banking Authority

AIIB:

Asian Infrastructure Investment Bank

ESMA:

European Securities and Market Authority

OECD:

Organisation for Economic Co-operation and Development

ECB:

European Central Bank

BIS:

Bank for International Settlements

UNCTAD:

United Nations Conference on Trade and Development

LBS:

Locational Banking Statistics

CPIS:

Coordinated Portfolio Investment Surveys

IMF:

International Monetary Fund

BSI:

Balance Sheet Items Statistics

PPML:

Pseudo Poisson Maximum Likelihood

LTV:

Loan to Value

References

  • Ahearne AG, Griever WL, Warnock FE (2004) Information costs and home bias: an analysis of US holdings of foreign equities. J Int Econ, Elsevier 62(2):313–336

    Article  Google Scholar 

  • Anderson JE (2011) The gravity model. Annu Rev Econ 3:133–160

    Article  Google Scholar 

  • Anderson JE, Van Wincoop E (2003) Gravity with gravitas: a solution to the border puzzle. Am Econ Rev 93:170–192

    Article  Google Scholar 

  • Aviat, A., Coeurdacier, N. (2007), The geography of trade in goods and asset holdings, Journal of International Economics Vol. 71, Issue 1, 8 March 2007, Pages 22–51

  • Bachmann R, Ruth S (2017) Systematic monetary policy and the macroeconomic effects of shifts in loan-to-value ratios, contribution at the conference of the macroeconomic committee. Université du Luxembourg 30 June - 1 July 2017

  • Balli F (2008) New Patterns of International Portoflio Allocation and Income Smoothing. Working Paper, Massey University

  • Balli F, Louis RJ, Osman M (2008) International portfolio inflows to GCC markets. Are there any general patters? MPRA Paper 10158

  • Balta N, Delgado J (2008) Home bias and market integration in the EU. CESifo Economic Studies 55(1):110–144

    Article  Google Scholar 

  • Barrell R, Pain N (1997) Foreign direct investment, technological change, and economic growth within Europe. Econ J 107:1770–1786

    Article  Google Scholar 

  • Berkel B (2007) Institutional determinants of international equity portfolios – a country level analysis. BEJM 7(1):34

    Article  Google Scholar 

  • Bertaut, C., Kole, L.S. (2004), What Makes Investors Over or Underweight? Explaining International Appetites for Foreign Equities, International Finance Discussion Paper No. 819, Board of Governors of the Federal Reserve System

  • Born, A., Enders, Z. (2018), Global banking, trade, and the international transmission of the great recession, CESifo Working Paper No 6912, http://www.cesifo-group.de/DocDL/cesifo1_wp6912.pdf. Access date 7 Jan 2019

  • Brei, M., Von Peter, G. (2017), The Distance Effect in Banking and Trade BIS, Working Papers No. 658, Bank for International Settlements

  • Bruno R, Campos N, Estrin S, TIAN M (2016) Technical Appendix to ‘The Impact of Brexit on Foreign Investment in the UK’. Gravitating Towards Europe: An Econometric Analysis of the FDI Effects of EU Membership. Center for Economic Performance, London School of Economics and Political Science, London

    Google Scholar 

  • Buch CM (2002) Are banks different? Evidence from international data? Int Financ 5(1):97–114

    Article  Google Scholar 

  • Buch CM (2005) Distance and international banking. Rev Int Econ 13(4):787–804

    Article  Google Scholar 

  • Chan K, Covrig V, Ng L (2005) What determines domestic Bias and foreign Bias? Evidence from mutual fund equity allocations worldwide, The. J Financ 60(3):1495–1534

    Article  Google Scholar 

  • Coeurdacier N, Guibaud S (2005) International equity holdings and stock returns correlations: does diversification matter at all for portfolio choice? Working paper, London business school

  • Coeurdacier N, Martin P (2009) The geography of asset trade and the euro: insiders and outsiders. Journal of Japanese and International Economies 23(2):90–113

  • Coeuré, B. (2017), European CCPs after Brexit, speech to the global financial markets association, Frankfurt (20 June 2017), https://www.bis.org/review/r170706b.pdf. Access date 7 Jan 2019

  • Daude C, Fratzscher M (2008) The pecking order of cross-border investment. J Int Econ 74:94–119

    Article  Google Scholar 

  • De Santis RA, Gerard B (2009) International portfolio reallocation: diversification benefits and European monetary union. Eur Econ Rev, 2009 53(8):1010–1027

    Article  Google Scholar 

  • Donnery, S. (2017), Remarks by Ms. Sharon Donnery, deputy governor (central banking) central Bank of Ireland at Chatham house, London, (23 March 2017), https://www.bis.org/review/r170405h.pdf

  • Dunning JH (1979) Explaining changing patterns of international production: in defence of the eclectic theory. Oxf Bull Econ Stat 41(4):269–295

    Article  Google Scholar 

  • Dunning JH (1998) Location and the multinational Enterprise – a neglected factor? J Int Bus Stud 29(1):45–66

    Article  Google Scholar 

  • Dunning JH (2001) The eclectic (OLI) paradigm of international production: past, present and future. Int J Econ Bus 8(2):173–190

    Article  Google Scholar 

  • Eichengreen, B. (2018), The international financial implications of Brexit, University of California at Berkeley, Forthcoming in International Economics and Economic Policy

  • Eichengreen B, Luengnaruemitchai P (2006) Bond Markets as Conduits for Capital Flows: How Does Asia Compare? NBER Working Paper No.12408. National Bureau of Economic Research, Cambridge

    Book  Google Scholar 

  • Faruqee H, Li S, Yan I (2004) The determinants of international portfolio holdings and home Bias, IMF working paper no.04/34. International Monetary Fund, Washington D.C.

    Google Scholar 

  • Fidrmuc J (2008) Gravity models in integrated panels. Empir Econ 37(2):435–446

    Article  Google Scholar 

  • Forbes KJ (2008) Why do Foreigners Invest in the United States? NBER Working Paper No.13908. National Bureau of Economic Research, Cambridge

    Book  Google Scholar 

  • Friewald NJ, Subrahmanyam R (2012) M.G. (2012), illiquidity or credit deterioration: a study of liquidity in the US corporate bond market during financial crises. J Financ Econ 105(1):18–36

    Article  Google Scholar 

  • Froot K, Stein J (1991) Exchange rates and foreign direct investments. Q J Econ 106(4):1191–1217

    Article  Google Scholar 

  • Gande, A., Parsely, D., Wei, S.J. (2009), Does source country corporate governance affect international investment patterns? Working paper, Columbia business school

  • Garcia-Herrero A, Wooldridge P, Yang DY (2009) Why Don't Asians invest in Asia? The determinants of cross-border portfolio holdings. AEP 8(3):228–256

    Google Scholar 

  • Gehrig T (1998) Cities and the geography of financial Centres, CEPR discussion paper no. 1894, London

  • Gelos GR, Wei SJ (2005) Transparency and international portfolio holdings. J Financ 60(6):2987–3020

    Article  Google Scholar 

  • Ghosh S, Wolf H (2000) Is there a curse of location? Spatial determinants of capital flows to emerging markets. In: Edwards S (ed) Capital flows and the emerging economies. University of Chicago Press, Chicago, pp 137–158

    Google Scholar 

  • Hahm JH, Shin K (2009) Complementarity among international asset holdings. IJFS 23:37–55

    Google Scholar 

  • Head, K., Mayer, T. (2014), Gravity equations: workhorse, toolkit and cookbook. In Handbook of International Economics. Edited by Gene M. Grossman and Kenneth S. Rogoff. New York: Elsevier, Vol. 4, Chap 3, pp. 131–195

  • HM GOVT (2016) HM Treasury analysis: the long-term economic impact of EU membership and the alternatives, London April 2016

  • Jeanneau, S., Micu, M. (2002), Determinants of International Bank Lending to Emerging Market Countries, BIS Working Paper No. 112, Bank for International Settlements

  • Jungmittag A, Welfens PJJ (2016) Beyond EU-US trade dynamics: TTIP effects related to foreign direct investment and innovation. EIIW Paper 212

  • Kim, S., Lee, J.W., Shin K. (2006), Regional and Global Financial Integration in East Asia, Working Paper, Tufts University

  • Kim W, Sung T, Wei SJ (2007) Does Corporate Government Risk at Home Affect Investment Choices Abroad? NBER Working Paper No.13721. National Bureau of Economic Research, Cambridge

    Google Scholar 

  • Knickerbocker FT (1973) Oligopolistic reaction and multinational enterprises. Harvard University Press, Oligopolistic reaction and multinational enterprise, Cambridge

    Book  Google Scholar 

  • Lane, P. (2005), Global bond portfolios and EMU, European Central Bank Working Paper No 553

  • Lane, P., Milesi-Ferretti, G.M (2005), The International Equity Holdings of Euro Area Investors, Working Paper, Trinity College and IMF

  • Lane P, Milesi-Ferretti GM (2008) International investment patterns. Rev Econ Stat 90(3):538–549

    Article  Google Scholar 

  • Martin P, Rey H (2004) Financial super-markets: size matters for asset trade. J Int Econ 64:335–361

    Article  Google Scholar 

  • Okawa Y, Van Wincoop E (2012) Gravity in international finance. J Int Econ 87:205–215

    Article  Google Scholar 

  • Pendle, L. (2007), What Determines Australia's Foreign Equity Investment?, Working Paper, University of Sydney

  • Poelhekke, S. (2014), Do global banks facilitate foreign investment?, working paper, VU University Amsterdam and Dutch central Bank

  • Portes R, Rey H (2005) The determinants of cross-border equity flows. J Financ Econ 65:269–296

    Google Scholar 

  • Portes R, Rey H, Oh Y (2001) Information and capital flows: the determinants of transactions in financial assets. Eur Econ Rev 45:783–796

    Article  Google Scholar 

  • Rose AK, Spiegel MM (2004) A gravity model of sovereign lending: trade, vol 51. Default and Credit, IMF Staff Papers, pp 50–63

  • Salins V, Benassy-Quere A (2006) Institutions and bilateral asset holdings, vol 2006-19. CEPII Working Paper

  • Sapir, A., Schoenmaker, D., Veron, N. (2017), Making the best of Brexit for the EU27 financial system, POLICYBRIEF issue 1, February 2017. http://bruegel.org/wp-content/uploads/2017/02/Bruegel_Policy_Brief-2017_01-060217.pdf

  • Tinbergen J (1962) Shaping the world economy: suggestions for an international economic policy. The Twentieth Century Fund, New York

    Google Scholar 

  • Vlachos J (2004) Do regulatory similarities increase bilateral portfolio holdings? CEPR discussion paper no.4417. In: Centre for economic policy research

    Google Scholar 

  • Welfens PJJ, Baier F (2018) BREXIT and foreign direct investment: key issues and new empirical findings. International Journal of Financial Studies 6(2):46. https://doi.org/10.3390/ijfs6020046

    Article  Google Scholar 

  • Yu G (2009) Accounting standard and international portfolio holdings: analysis of cross-border holdings following mandatory adoption of IFRS, working paper. University of Michigan Ross School of Business

Download references

Acknowledgements

This paper is part of EIIW research funded by the Deutsche Bundesbank. While the authors gratefully acknowledge funding from the Deutsche Bundesbank within the project “The Influence of Brexit on the EU28: Banking and Capital Market Adjustments as well as Direct Investment Dynamics in the Eurozone and other EU Countries”, opinions expressed within represent those of the authors and do not reflect the views of the Deutsche Bundesbank or its staff. We gratefully acknowledge research assistance by Christina Peussner and editorial assistance by Kennet Stave and David Hanrahan (EIIW), as well as comments from the participants of the 4th FDI workshop November 2019 in Mainz; and the EIIW project workshop 2018 at HIS Markit, Frankfurt. The usual disclaimer applies.

Author information

Authors and Affiliations

  1. EIIW at the University of Wuppertal and Schumpeter School of Business and Economics, Wuppertal, Germany

    Fabian J. Baier

  2. Johns Hopkins University, Washington, DC, USA

    Paul J. J. Welfens

Authors
  1. Fabian J. Baier
    View author publications

    You can also search for this author in PubMed Google Scholar

  2. Paul J. J. Welfens
    View author publications

    You can also search for this author in PubMed Google Scholar

Corresponding author

Correspondence to Fabian J. Baier.

Additional information

Publisher’s Note

Springer Nature remains neutral with regard to jurisdictional claims in published maps and institutional affiliations.

Appendix

Appendix

Rights and permissions

Reprints and permissions

About this article

Check for updates. Verify currency and authenticity via CrossMark

Cite this article

Baier, F.J., Welfens, P.J.J. The UK’s banking FDI flows and Total British FDI: a dynamic BREXIT analysis. Int Econ Econ Policy 16, 193–213 (2019). https://doi.org/10.1007/s10368-018-00426-x

Download citation

  • Published:

  • Issue Date:

  • DOI: https://doi.org/10.1007/s10368-018-00426-x

Keywords

JEL classification

Search

Navigation