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International Trade Theory Meets Banking

May 24, 2018

“Let’s look at banks as firms.”

This is the thought that has spurred the research of Professor of Economics David VanHoose most of his career. A few years ago, he took it a step further, wondering, “If banks act as firms, what if we apply international trade theory to the idea of banks as firms?”

So VanHoose hit the books. During a one-semester sabbatical, he brushed up on international trade theory. His original article applying international trade theory to banks, “A Model of International Trade in Banking Services” was published in Open Economies Review in 2013.

Building on the concept in a recent article published in the Journal of International Financial Markets, Institutions & Money, VanHoose looked to the Heckscher-Ohlin model of international trade as a guide. The model asserts the importance of factor abundance and factor intensity to international trade. In his article, "Capital Intensities and International Trade in Banking Services," VanHoose focused on factor intensity as it applies to banking to evaluate its effects on net exports and imports of loans and deposits. (Factor intensity is loosely defined as how much physical capital versus labor a firm uses.)

“What I tried to do in this paper is take all the research and information about banking and pull in international trade theory,” VanHoose said. “What might be driving cross-border movements of funds, in the form of loans and deposits? What really drives most flows [of funds] are individuals trying to spread risks in their portfolios. What I did was develop this theory in which banks use labor and physical capital to produce these loans and deposit services they provide. Decisions about allocating these resources also contribute to the flow of funds.”

With co-author Enzo Dia, VanHoose looked at how banks’ intensity of use of labor and physical capital impacted their success across international markets, since factor intensities vary across nations’ banking systems.

“It still differs in countries, and we see that in the data,” he said. “On top of this, the theory says factor intensities should vary for loans versus deposits. What should be true is that intensities of labor versus intensities of physical capital should differ for banks’ deposit-related operations and for their loan functions, and we find there are definite international differences.”

The data suggests there is evidence net exports of deposits and net exports of loans vary with capital intensities—the physical capital that banks allocate to providing loan and deposit services.

“I’m always surprised when I develop a theory that the data can support,” he laughed. “We find definite support for the theory. It appears that international trade considerations that affect firms all over the world, also affect banks. Realistically, though, the traditional finance story about portfolio diversification still matters too.”

In the future, VanHoose would be interested to separate how portfolio diversification and international trade considerations together contribute to how funds flow across borders in the banking industry.

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