The Currency Channel of the Global Bank Leverage Cycle

Justine Pedrono

Working papers from Banque de France

Abstract: The amplitude of leverage procyclicality is heterogeneous across banks and across countries. This paper introduces international diversification of bank balance sheet as a factor of this observed heterogeneity, with a special emphasis on currency diversification. Based on a new theoretical framework, it shows that the impact of international diversification on leverage procyclicality depends on the relative performance of economies, the global business cycle and the exchange rate regime. By altering the distribution of global bank portfolio, international diversification adds a currency channel to the risk channel of the global leverage cycle. Using granular data on banks located in France, the paper shows that the pre-crisis international diversification of banks increased leverage procyclicality during the 2008-2009 crisis. Focusing on the currency channel, namely the valuation effect of currency diversification, results show that it had a negative effect on leverage procyclicality during this period, hence decreasing procyclicality. The currency channel contributed to offset part of the increased risk due to the crisis and the risk channel. These findings draw attention to the specific role of balance sheet currency diversification in financial stability risk.

Keywords: Bank; Financial Cycles; Leverage; Internationalization; International Portfolio; Currency (search for similar items in EconPapers)
JEL-codes: E32 F34 F36 F44 G15 G20 (search for similar items in EconPapers)
Pages: 50 pages
Date: 2022
New Economics Papers: this item is included in nep-ban, nep-dem, nep-ifn, nep-mac, nep-mon and nep-opm
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Persistent link: https://EconPapers.repec.org/RePEc:bfr:banfra:870

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