Working Paper: NBER ID: w23316
Authors: Falk Brauning; Victoria Ivashina
Abstract: When central banks adjust interest rates, the opportunity cost of lending in local currency changes, but—in absence of frictions—there is no spillover effect to lending in other currencies. However, when equity capital is limited, global banks must benchmark domestic and foreign lending opportunities. We show that, in equilibrium, the marginal return on foreign lending is affected by the interest rate differential, with lower domestic rates leading to an increase in local lending, at the expense of a reduction in foreign lending. We test our prediction in the context of changes in interest rates in six major currency areas.
Keywords: Monetary Policy; Global Banking; Interest Rates; Lending Behavior; Capital Constraints
JEL Codes: E44; E52; F31; G21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Domestic Interest Rate Decrease (E43) | Local Lending Increase (G21) |
| Domestic Interest Rate Decrease (E43) | Foreign Lending Decrease (F34) |
| Foreign Lending Decrease (F34) | Banks with Lower Equity-to-Assets Ratios (G21) |
| Domestic Interest Rate Decrease (E43) | Foreign Lending Decrease (more substantial) (F34) |