Cultural stereotypes of multinational banks

Financial markets, even more than other markets, run on trust.  Complete contracts accounting for all conceivable contingencies are a textbook abstraction.  Adjudication by courts is time consuming and unpredictable.  For transactions to be sustained, counterparties must be trusted.  This is why one observes a concentration of commercial and financial transactions among individuals with a common cultural background who share extra-economic links, values and trust. 

While the connections between trust and economic behaviour are general, such considerations apply with special force to investments in the bonds of foreign governments.  Government bonds are incomplete contracts, as demonstrated by the history of default, restructuring and repudiation.  Multiple countries make for multiple courts with uncertain jurisdiction.  Governments enjoy a degree of sovereign immunity, casting doubt on the existence of a judicial solution to default.  Such considerations heighten reliance on trust as an alternative to legal contract enforcement. 

At the same time, cultures and values, from which trust derives, differ across countries.  In many cases they differ more dramatically across countries than within them, which again points to importance of trust in the context of international investment. Sovereign bonds tap into these cultural stereotypes, since they are directly associated with a national government and nationality. 

This paper combines data on banks’ investments in European sovereign debt, together with survey data on how much Europeans trust each other, to show that trust has an important impact on cross-border investments. The paper finds that during the years from 2010-21, when residents of the country or countries where a bank operates have a high level of trust in residents of another country, the bank is more likely to hold claims on that other country.  By controlling for other characteristics of the individual bank and the government that is the target its of investment, the analysis rules out the possibility that the measure of trust is picking up other financial, informational or political influences.

Click here to go to the paper by Barry Eichengreen and Orkun Saka.