Foreign Currency Borrowing by Small Firms

82 Pages Posted: 17 Nov 2009

See all articles by Martin Brown

Martin Brown

University of St. Gallen

Steven Ongena

University of Zurich - Department of Banking and Finance; Swiss Finance Institute; KU Leuven; Centre for Economic Policy Research (CEPR)

Pinar Yesin

Swiss National Bank

Multiple version iconThere are 4 versions of this paper

Date Written: November 2009

Abstract

We examine the firm- and country-level determinants of the currency denomination of small business loans. We first model the choice of loan currency in a framework which features a trade-off between lower cost of debt and the risk of firm-level distress costs, and also incorporates the impact of information asymmetry between banks and firms. When foreign currency funds come at a lower interest rate, all foreign currency earners as well as those local currency earners with high revenues and low distress costs choose foreign currency loans. When the banks have imperfect information on the currency and level of firm revenues, even more local earners switch to foreign currency loans, as they do not bear the full cost of the corresponding credit risk.

We then test the implications of our model by using a 2005 survey with responses from 9,098 firms in 26 transition countries. The survey contains details on 3,105 recent bank loans. At the firm level, our findings suggest that firms with foreign currency income and assets are more likely to borrow in a foreign currency. In contrast, firm-level distress costs and financial transparency affect the currency denomination only weakly. At the country level, the interest rate advantages of foreign currency funds and the exchange rate volatility do not explain the foreign currency borrowing in our sample. However, foreign bank presence, weak corporate governance and the absence of capital controls encourage foreign currency borrowing. All in all, we cannot confirm that "carry-trade behavior" is the key driver of foreign currency borrowing by small firms in transition economies. Our results do, however, support the conjecture that banking-sector structures and institutions that aggravate information asymmetries may facilitate foreign currency borrowing.

Keywords: banking structure, competition, foreign currency borrowing, market structure

JEL Classification: F34, F37, G21, G30

Suggested Citation

Brown, Martin and Ongena, Steven R. G. and Yeşin, Pınar, Foreign Currency Borrowing by Small Firms (November 2009). CEPR Discussion Paper No. DP7540. Available at SSRN: https://ssrn.com/abstract=1507536

Martin Brown (Contact Author)

University of St. Gallen ( email )

Unterer Graben 21
St. Gallen, CH-9000
Switzerland

Steven R. G. Ongena

University of Zurich - Department of Banking and Finance ( email )

Schönberggasse 1
Zürich, 8001
Switzerland

Swiss Finance Institute

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

KU Leuven ( email )

Oude Markt 13
Leuven, Vlaams-Brabant 3000
Belgium

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Pınar Yeşin

Swiss National Bank ( email )

Boersenstrasse 15, P.O.Box
Zuerich, CH-8022
Switzerland
41-58-631-3969 (Phone)

HOME PAGE: http://www.pinaryesin.com

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