Shock Transmission through Global Banking: A Granular Instrument Variable Approach *

Abstract

How do economic disturbances propagate across borders through international banking? Using detailed data on U.S. banks' exposures to foreign countries, we first examine how developments in foreign countries impact U.S. banks. Then we look at how shocks to foreign countries affect the U.S. economy at the county level through U.S. banks' international exposures. Exploiting the within-bank geographic concentration of foreign exposures, we employ the novel granular instrumental variable (GIV) methodology newly developed by Gabaix and Koijen (2024) for identification. We find that shocks originating in foreign countries significantly impact domestic lending of U.S. banks and employment of U.S. counties.

Keywords: E24, E32 International Banking, Shock Transmission, Granular Instrument Variable