Unraveling Exchange Rate Shocks: Disentangling Extensive and Intensive E?ects on the Lending Channel

Abstract

This study investigates how exchange rate fluctuations transmit to the real economy through the bank lending channel, with a focus on the moderating role of bank liquidity. Using high-frequency monthly data from Iranian banks (2007–2018), we exploit Iran’s unique institutional setting—where official FX rates shield balance sheets from valuation effects—to isolate extensive-margin adjustments in loan supply. We find that a 10% exchange rate appreciation reduces real loan growth by 0.4 percentage points, equivalent to 30% of aver- age monthly growth. Crucially, this effect is amplified for banks with weaker liquidity buffers and higher non-performing loans, underscoring the role of bank health in shock absorption. Disaggregated analysis reveals sharper de- clines in private-sector and local-currency loans, suggesting that credit allo- cation shifts during currency shocks. Robust to instrumental variables and dynamic GMM specifications, our results highlight liquidity buffers as a key policy tool to mitigate lending contractions during FX volatility. These find- ings advance the literature on financial frictions in open economies and offer actionable insights for macroprudential regulation in emerging markets.

Keywords: Exchange Rate Fluctuations, Lending Channel, Loan Supply, Banking Soundness, Liquidity Ratios

JEL Classification: E44, E52, G21, F31