Exchange rate risk, banks' currency mismatches, and credit supply

We exploit the post-Brexit depreciation of the British pound as an exogenous shock to show how exchange rate shocks transmit to the German real economy through the banking sector. German banks with GBP currency mismatches (between assets and liabilities, including off-balance sheet items) suffer los...

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Bibliographic Details
Published in:Journal of international economics 2023-03, Vol.141, p.103725, Article 103725
Main Authors: Abbassi, Puriya, Bräuning, Falk
Format: Article
Language:English
Subjects:
Credit supply
Currency mismatch
Financial intermediation
Financial stability
Foreign exchange risk
Risk migration
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Summary:We exploit the post-Brexit depreciation of the British pound as an exogenous shock to show how exchange rate shocks transmit to the German real economy through the banking sector. German banks with GBP currency mismatches (between assets and liabilities, including off-balance sheet items) suffer losses when the currency of assets depreciates relative to that of liabilities, which they internalize by cutting back credit supply. For a one percentage-point loss in equity, a bank cuts credit supply by 73 basis points on average, with stronger effects for banks with lower equity capital. The credit contraction of German banks (i) affects also firms that are not directly related to UK conditions, (ii) holds across all industries, including non-tradable sectors, (iii) impacts relatively more small borrowers, and (iv) decreases affected firms' investments.
ISSN:0022-1996
1873-0353
DOI:10.1016/j.jinteco.2023.103725