Financial Stability Effects of Foreign-Exchange Risk Migration

49 Pages Posted: 18 Nov 2019

See all articles by Puriya Abbassi

Puriya Abbassi

Deutsche Bundesbank

Falk Bräuning

Federal Reserve Banks - Federal Reserve Bank of Boston

Date Written: November 7, 2019

Abstract

Firms trade derivatives with banks to mitigate the adverse impact of exchange-rate fluctuations. We study how the related migration of foreign exchange (FX) risk is managed by banks and affects both credit supply and real economic variables. For identification, we exploit the Brexit referendum in June 2016 as a quasi-natural Experiment in combination with detailed micro-level FX derivatives data and the credit register in Germany. We show that, prior to the referendum, the corporate sector substantially increased the usage of derivatives, and banks on the other side of the trade did not fully intermediate that FX risk, but retained a large proportion of it in their own books. As a result, the depreciation of the British pound in the aftermath of the Referendum poses a shock to the capital base of affected banks. We show that loss-facing banks in response cut back credit to firms, including to those without FX exposure to begin with. These results are stronger for less capitalized banks. Firms with ex-ante exposure to loss-facing banks experience a 32 percent larger reduction in credit than industry peers, and a stronger reduction in cash holdings and investment of about 8 and 2 percent, respectively. Our results show how a bank's uninsured derivatives book can take one corporation's FX risk and turn it into another corporation's financing risk.

Keywords: Foreign Exchange Risk, Financial Intermediation, Risk Migration, Financial Stability

JEL Classification: D53, D61, F31, G15, G21, G32

Suggested Citation

Abbassi, Puriya and Bräuning, Falk, Financial Stability Effects of Foreign-Exchange Risk Migration (November 7, 2019). Available at SSRN: https://ssrn.com/abstract=3483234 or http://dx.doi.org/10.2139/ssrn.3483234

Puriya Abbassi (Contact Author)

Deutsche Bundesbank ( email )

Wilhelm-Epstein-Str. 14
Frankfurt/Main, 60431
Germany
00496965993708 (Phone)

Falk Bräuning

Federal Reserve Banks - Federal Reserve Bank of Boston ( email )

600 Atlantic Avenue
Boston, MA 02210
United States

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