Finance: Research, Policy and Anecdotes

In a new paper, Peter Bednarek, Daniel Te Kaat and Natalja von Westernhagen and I use German credit registry data to assess the effect of the sharp depreciation of the euro against the US dollar of more than 20% in 2014, thus testing directly for the role of banks’ foreign currency holdings in the transmission of exchange rate fluctuations to the real economy. This depreciation was largely unexpected for financial market participants and certainly exogenous to German banks and firms’ behaviour.

Our analysis provides three main results. First, the euro depreciation encourages larger banks with significant net foreign-currency asset exposure (and thus higher net worth following the dollar’s appreciation) to expand their credit supply. Second, this increase can be explained by growth in loan supply to export-intensive firms, not to riskier firms, and, even more important, by an increase in interbank market activity. In particular, large banks with significant net foreign-currency assets raise their interbank lending to small banks without significant foreign-currency asset exposure, but with a higher share of exporting firms in their credit portfolio, which in turn also allows small banks to expand their credit supply. Third, we show that exporting firms borrowing from smaller banks with higher interbank market dependence increase their investment following the exchange rate depreciation and that regions with local banks benefiting from this increase in interbank borrowing experience significantly higher GDP growth than less exposed regions.

While previous research (Agarwal, 2019) shows that exchange rate depreciations (appreciations) can lead to an increase (decrease) in domestic credit and higher (lower) aggregate growth when the domestic banking sector has high net foreign-currency asset exposure, our contribution is that with the use of granular bank-firm-loan-level data we can provide evidence for specific mechanisms through which exchange rate changes can affect loan supply, i.e., through direct lending and interbank lending, and link these mechanisms to real economic effects.

Here the link to the VoXEU column, with a longer discussion of the paper.

Overview