Foreign Banks, Liquidity and International Capital Flows: Evidence from Korea

This paper documents and analyzes the increasing role of foreign banks in Korea in recent years. Using macroeconomic and banking data for the period of 2000Q1-2016Q2, we present evidence that foreign bank branches in Korea have responded to the changes in monetary policies in their home countries (the US, in particular) in providing foreign currency loans and affecting the direction and magnitude of international capital flows via the banking sector in Korea. As the monetary policy interest rate gap between (1) Korea (BOK base rates) and (2) the U.S. (the fed funds rates) increases in favor of Korea, foreign banks’ foreign currency loans in Korea have increased with a one quarter (3-month) lag time period. Cross-border bank loans and international capital flows via the banking sector in Korea have also shown a similar pattern of lagged responses to monetary policy shocks transmitted from the U.S. to Korea. The paper also derives important policy implications.