Bank Cost Efficiency and Credit Market Structure Under a Volatile Exchange Rate
57 Pages Posted: 27 Apr 2022 Last revised: 12 Sep 2022
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Bank Cost Efficiency and Credit Market Structure Under a Volatile Exchange Rate
Bank Cost Efficiency and Credit Market Structure Under a Volatile Exchange Rate
Date Written: May 13, 2022
Abstract
We study the differential impact of exchange rate volatility on cost efficiency and market structure when banks have non-trivial exposures to foreign currency operations. We use unique data on quarterly revaluations of assets and liabilities denominated in foreign currencies that Russian banks were reporting between 2004Q1 and 2020Q2. First, we document that cost efficiency estimates are both severely downward biased---by 30 p.p. on average---and generally not rank preserving when these quarterly revaluations are ignored. However, using nonparametric copulas, we also reveal an extreme tail dependence in the bank cost efficiency rankings constructed with the revaluations being kept or dropped. Second, we show that the revaluations are fueled by the banks' negative mismatch in foreign currencies which, in turn, is mostly driven by household deposits in foreign currencies and the instability of Ruble's exchange rate. Third, we find that keeping the revaluations when estimating bank cost efficiency leads to a misleading conclusion that the credit market is inefficient; we show that this is driven by the upper quartile of the banks' distribution by total assets. Fourth, to ensure generalizability to other emerging market economies (EMEs), we suggest a two-stage approach that does not rely on our unique data on revaluations but rather employs banks' exposures to foreign currencies and aggregate exchange rate volatility. With this approach, we can close the downward bias in efficiency estimates by two-thirds and still establish that the (dollarized) credit market is efficient.
Keywords: Banks, Foreign currency operations, Currency revaluation, Bank production, Bank ownership, Market structure, Copulas
JEL Classification: G21, D24, L25
Suggested Citation: Suggested Citation