Working Paper: CEPR ID: DP7540
Authors: Martin Brown; Steven Ongena; Pinar Yein
Abstract: We examine the firm- and country-level determinants of the currency denomination of small business loans. We first model the choice of loan currency in a framework which features a trade-off between lower cost of debt and the risk of firm-level distress costs, and also incorporates the impact of information asymmetry between banks and firms. When foreign currency funds come at a lower interest rate, all foreign currency earners as well as those local currency earners with high revenues and low distress costs choose foreign currency loans. When the banks have imperfect information on the currency and level of firm revenues, even more local earners switch to foreign currency loans, as they do not bear the full cost of the corresponding credit risk.We then test the implications of our model by using a 2005 survey with responses from 9,098 firms in 26 transition countries. The survey contains details on 3,105 recent bank loans. At the firm level, our findings suggest that firms with foreign currency income and assets are more likely to borrow in a foreign currency. In contrast, firm-level distress costs and financial transparency affect the currency denomination only weakly. At the country level, the interest rate advantages of foreign currency funds and the exchange rate volatility do not explain the foreign currency borrowing in our sample. However, foreign bank presence, weak corporate governance and the absence of capital controls encourage foreign currency borrowing. All in all, we cannot confirm that "carry-trade behavior" is the key driver of foreign currency borrowing by small firms in transition economies. Our results do, however, support the conjecture that banking-sector structures and institutions that aggravate information asymmetries may facilitate foreign currency borrowing.
Keywords: Banking Structure; Competition; Foreign Currency Borrowing; Market Structure
JEL Codes: F34; F37; G21; G30
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| foreign currency income (F31) | foreign currency borrowing (F34) |
| foreign currency assets (F31) | foreign currency borrowing (F34) |
| local currency earnings + high revenues + low distress costs (G33) | foreign currency borrowing (F34) |
| information asymmetry (D82) | foreign currency borrowing (F34) |
| foreign bank presence (F65) | foreign currency borrowing (F34) |
| weak corporate governance (G38) | foreign currency borrowing (F34) |