Dollar funding and the lending behavior of global banks

Victoria Ivashina, David Scharfstein and Jeremy C. Stein

No 2012-74, Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (U.S.)

Abstract: A large share of dollar-denominated lending is done by non-U.S. banks, particularly European banks. We present a model in which such banks cut dollar lending more than euro lending in response to a shock to their credit quality. Because these banks rely on wholesale dollar funding, while raising more of their euro funding through insured retail deposits, the shock leads to a greater withdrawal of dollar funding. Banks can borrow in euros and swap into dollars to make up for the dollar shortfall, but this may lead to violations of covered interest parity (CIP) when there is limited capital to take the other side of the swap trade. In this case, synthetic dollar borrowing becomes expensive, which causes cuts in dollar lending. We test the model in the context of the Eurozone sovereign crisis, which escalated in the second half of 2011 and resulted in U.S. money-market funds sharply reducing their funding to European banks. Coincident with the contraction in dollar funding, there were significant violations of euro-dollar CIP. Moreover, dollar lending by Eurozone banks fell relative to their euro lending in both the U.S. and Europe; this was not the case for U.S. global banks. Finally, European banks that were more reliant on money funds experienced bigger declines in dollar lending.

Date: 2012
New Economics Papers: this item is included in nep-ban, nep-eec, nep-mon and nep-opm
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Citations: View citations in EconPapers (30)

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Related works:
Working Paper: Dollar Funding and the Lending Behavior of Global Banks (2012)
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