Cross-Border Capital Flows and Bank Risk-Taking

This paper explores the impact of cross-border capital flows on bank lending volumes and risk. Employing bank-level data from the euro area, we show that capital inflows are associated with higher bank credit supply and lower average loan quality. By showing that the lending patterns of smaller domestic banks are also affected, we present evidence that the impact of international capital flows is not limited to large banks with international exposure. Nevertheless, the observed effects are stronger for large banks as well as for banks with low levels of capitalisation, suggesting that agency issues reinforce the link between capital flows and bank lending.