Working Paper: CEPR ID: DP17852
Authors: Kristin Forbes; Christian Friedrich; Dennis Reinhardt
Abstract: This paper explores whether different funding structures - including the source, instrument, currency, and counterparty location of funding - affected the extent of financial stress experienced in different countries and sectors during the period of acute financial stress as Covid-19 spread in early 2020. We measure financial stress using a new dataset on changes in credit default swap spreads for sovereigns, banks, and corporates. Then we use country-sector and country-sector-time panels to assess if these different funding structures mitigated—or amplified—the impact of this risk-off shock. A higher share of funding from non-bank financial institutions (NBFI) or in US dollars was correlated with significantly greater stress, while a higher share of funding in debt instruments (instead of loans) or cross-border (instead of domestically) did not significantly impact resilience. The results suggest that macroprudential regulations should broaden their current focus to take into account exposures to NBFI and dollar funding, with less priority for regulations focused on residency (i.e., capital controls). After the sharp increase in financial stress in early 2020, policy responses targeting these structural vulnerabilities (i.e., US$ swap lines and focused on NBFIs) were more effective at mitigating stress related to these funding structures than policies supporting banks, even after controlling for macroeconomic policy responses.
Keywords: COVID-19; financial stress; funding structure; nonbank financial institutions; shadow banks; macroprudential policy; swap lines
JEL Codes: E44; E65; F31; F36; F42; G18; G23; G38
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| higher share of funding from nonbank financial institutions (NBFIs) (G21) | financial stress (G51) |
| higher share of funding from household deposits (G21) | financial stress (G51) |
| reliance on U.S. dollar funding (F65) | financial stress (G51) |
| type of funding instrument (loans vs. debt markets) (G21) | financial stress (G51) |