Exchange Rate Exposures of U.S. Banks: A Cash Flow-Based Methodology

Abstract

Using a cash flow-based framework, we decompose exchange rate into short-term and long-term elements for 105 individual U.S. banks over 1988-1998. We show that significant long-term exposure is more prevalent than significant short-term exposure, reflecting the difficulty in recognizing, modeling, and managing the longer-term effects of exchange rate risk. Our analyses reveal that 72% of internationally-oriented and 88% of domestically-oriented banks in the sample have significant exposure to at least one of five currency pairs. This result supports the theory that domestic banks are exposed and should be concerned about the indirect impact of exchange rate risk. Furthermore, we provide some evidence that economies of scale may exist for institutions with extensive international operations.

Keywords: U.S. banks, Currency exposure, Exchange rate exposure, Domestic exposure, Economies of scale

JEL Classification: F31, G21