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| In this paper we study interdependencies between corporate foreign investment and the capital structure of banks. By committing to invest predominantly at home firms can reduce the credit default risk of their lending banks. Therefore banks can refinance loans to a larger extent through deposits thereby reducing firms’ effective financing costs. Firms thus have an incentive to allocate resources inefficiently as they then save on financing costs. We argue that imposing minimum capital adequacy for banks can eliminate this incentive by putting a lower bound on financing costs. However the Basel II framework is shown to miss this potential. -- financial contracting ; multinational corporations ; internal capital markets |
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