From CIP Deviations to Global Capital Flows: Bank Lending Channel and Real Effects

Abstract

We show real effects from Covered Interest Parity (CIP) deviations using administrative data on Norwegian banks, firms, and their loans. Banks with access to U.S. money markets increase USD global funding by 4-5 percentage points in response to CIP deviations of 1 percentage point. Moreover, there is a bank lending channel associated with the global capital inflows: a firm receives 6 percentage points more credit supply from its global bank relative to its domestic bank. We then document two transmission channels of CIP deviations to the real economy. First, a credit reallocation channel: affected firms use most of the short-term credit to acquire other firm’s bonds. This channel is driven both by a desire to increase interest income and by precautionary motives. Second, affected firms expand firm sales. In aggregate, the latter channel implies approximately 4 percentage point higher cumulative sales growth in 2011 and 2012.

Keywords: CIP deviations, bank lending channel, global banks

JEL Classification: G21, F31, F65, E4