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Ongoing research finds “a feeling of trust in a country’s population is a vital component in a bank’s decision to lend to a government”. Liz Lumley reports.

Ongoing research into what influences investment decisions by the London School of Economics and Political Science (LSE) and the University of California, Berkeley has found that decisions around government lending can be impacted by cultural stereotypes.

The report found that “a feeling of trust in a country’s population is a vital component in a bank’s decision to lend to a government”. 

These new findings build on previous research into the propensity of investors to favour individuals and institutions with culturally similar backgrounds when choosing their investments. The study – ‘Cultural Stereotypes of Multinational Banks’ – highlights evidence of these types of influences when banks lend to governments as well. 

Using hand-collected data spanning more than a decade on European banks’ sovereign debt portfolios, the report shows that the trust of residents of a bank’s countries of operation in the residents of a potential target country of investment has a positive, statistically significant, and economically important association with its cross-border exposures. 

In identifying cultural stereotypes at the bank level, corporate cultures at bank headquarters are influenced by foreign subsidiaries for several reasons, including banks’ tendency to hire internally across borders for high-level managerial positions. 

The report highlights the impact of stereotypes, such as persistent overtime, which is stronger for less diversified banks and weaker for target countries whose bonds appear more frequently in bank portfolios. Cultural stereotypes are particularly salient when governments are hit by sovereign debt crises.

Cultural understanding

The study was conducted by Orkun Saka at the LSE and City, University of London, as well as Barry Eichengreen of the University of California, Berkeley and published by the LSE Systemic Risk Centre. The study used historical data from Eurobarometer surveys as a proxy for cultural stereotypes.

“It is a crude measure but resonates quite well with well-known cases such as low trust between UK and France, or Germany and Greece, etc,” says Mr Saka.

Mr Saka admits that cultural stereotypes can be complex and often multi-dimensional, taking in various ideas such as which country is best at playing football or cooking food. However, sometimes the basis comes from “legitimate reasons” such as countries which have had long periods of war, the consequence of which is a breakdown in trust.

Making the link

The research sheds light on how such cultural stereotypes are passed on to decision-makers in bank headquarters through multinational branch networks. 

Using the Eurobarometer data to measure bilateral trust between European populations, and recording the locations of bank headquarters and their branches across Europe, researchers found that banks’ sovereign debt exposures were strongly affected by the levels of trust expressed in the countries in which the banks operated. 

One thing is sure and it is that European banks’ sovereign portfolios are drastically under-diversified

Orkun Saka

The study also developed an innovative empirical framework to isolate the effect of trust as opposed to unobservable factors that might be influencing sovereign exposures across countries and time. 

Mr Saka says there are definitely large sums of money left on the table or, inversely, overexposure to risk, due to the cultural biases of bank managers carrying over into the workplace and distorting the optimal portfolio allocation of banks.

Banks must diversify

“One thing is sure and it is that European banks’ sovereign portfolios are drastically under-diversified; an average bank in Europe has no exposure at all to almost half of the countries in Europe (42% to be precise),” he says.

“This is very surprising given that we are talking about the safest asset category in the world (i.e. government bonds) which can be bought and sold in very liquid markets and for which the European regulation is very homogenous.”

High-level managerial flows within banks are instrumental in transmitting the culture from bank subsidiaries to headquarters, according to the study. The research also found that the geography of a bank’s branch network “strongly predicts” the nationalities represented in its board of directors and executive teams, adds Mr Saka. 

“This is consistent with the view that such employee transfers from branches to headquarters shape the idiosyncratic culture of the latter and thus influence decisions undertaken there,” he says. 

“We think that the best remedy to counteract such cultural biases is to improve the national diversity of these managerial teams at headquarters making sure that all cultural views are represented in decision-making. As some cultures have positive and others have negative perceptions of the same target investment (e.g. government bonds of a target country), this would tilt decision-making towards a more balanced perspective,” concludes Mr Saka.

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