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

Puriya Abbassi and Falk Bräuning

Journal of International Economics, 2023, vol. 141, issue C

Abstract: 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.

Keywords: Currency mismatch; Credit supply; Foreign exchange risk; Financial intermediation; Risk migration; Financial stability (search for similar items in EconPapers)
JEL-codes: D53 D61 F31 G15 G21 G32 (search for similar items in EconPapers)
Date: 2023
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:inecon:v:141:y:2023:i:c:s0022199623000119

DOI: 10.1016/j.jinteco.2023.103725

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