The Exchange Rate Disconnect and the Bank Lending Channel: Evidence from Switzerland

49 Pages Posted: 5 Jun 2018

Date Written: June 4, 2018

Abstract

Using the January 2015 episode of the Swiss franc appreciation as an exogenous exchange rate shock, this paper investigates the role of bank-lending channel in explaining the exchange rate disconnect puzzle. I construct a novel dataset on foreign currency exposure of Swiss banks and find that banks with a net liability foreign currency exposure experience a higher loan growth in the post-shock period relative to banks with a net foreign currency asset exposure. This credit supply shock positively affects investment of bank dependent firms and mitigates the negative effect of currency appreciation on exporters. This finding suggests that the bank lending channel of exchange rates offsets the negative effect of currency appreciation on exporting firms' investment, and can explain why currency appreciations are not always contractionary. This channel matters more for emerging markets as compared to advanced economies, and has important policy implications for monetary policy in small open economies.

Keywords: Bank Lending, Exchange Rates, Currency Mismatch, Open Economy

JEL Classification: G01, G21, G28, G30

Suggested Citation

Agarwal, Isha, The Exchange Rate Disconnect and the Bank Lending Channel: Evidence from Switzerland (June 4, 2018). Paris December 2018 Finance Meeting EUROFIDAI - AFFI. Available at SSRN: https://ssrn.com/abstract=3190647 or http://dx.doi.org/10.2139/ssrn.3190647

Isha Agarwal (Contact Author)

Cornell University ( email )

Ithaca, NY 14853
United States

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