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Banks' Leverage Procyclicality: Does US Dollar Diversification Really Matter?

Justine Pedrono () and Aurélien Violon

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Abstract: Assets of banks located in France are mainly denominated in euro and in US dollar. Currency diversification, which measures how much of assets are denominated in US dollar, implies a credit risk diversification and a valuation effect on assets. As currency diversification affects directly the total converted value of assets, it changes banks' debt capacity and their resilience to economic shocks. Thereby, currency diversification of assets should affect leverage responsiveness to the value of assets, namely the leverage procyclicality. Using innovative data on credit institutions located in France between1999 and 2014, we examine whether US dollar diversification of assets is pertinent for the analysis of leverage procyclicality. Focusing on investment banks, our results suggest that the net effect of US dollar diversification is dominated by the valuation effect. After extracting the valuation effect of diversification, it also posits the importance of two opposite effects in leverage procyclicality. Additionally, our results confirms the theoretical prediction where currency mismatch does not affect leverage procyclicality. Implicitly it supports the idea that leverage procyclicality is only driven by assets. Finally, our conclusions support the idea that US dollar diversification is relevant to the analysis of leverage procyclicality especially for the post crisis period.

Keywords: financial accelerator; currency mismatch; banks; currency diversification; procyclical leverage (search for similar items in EconPapers)
Date: 2016-02
New Economics Papers: this item is included in nep-mac
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