Working Paper: NBER ID: w25083
Authors: Toni Ahnert; Kristin Forbes; Christian Friedrich; Dennis Reinhardt
Abstract: Can macroprudential foreign exchange (FX) regulations on banks reduce the financial and macroeconomic vulnerabilities created by borrowing in foreign currency? To evaluate the effectiveness and unintended consequences of macroprudential FX regulations, we develop a parsimonious model of bank and market lending in domestic and foreign currency and derive four predictions. We confirm these predictions using a rich dataset of macroprudential FX regulations. These empirical tests show that FX regulations: (1) are effective in terms of reducing borrowing in foreign currency by banks; (2) have the unintended consequence of simultaneously causing firms to increase FX debt issuance; (3) reduce the sensitivity of banks to exchange rate movements, but (4) are less effective at reducing the sensitivity of corporates and the broader financial market to exchange rate movements. As a result, FX regulations on banks appear to be successful in mitigating the vulnerability of banks to exchange rate movements and the global financial cycle, but partially shift the snowbank of FX vulnerability to other sectors.
Keywords: macroprudential regulations; foreign exchange; financial stability
JEL Codes: F32; F34; G15; G21; G28
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| decrease in bank exposure to currency fluctuations (F33) | partial shifting of vulnerabilities to corporates (G32) |
| FX regulations (F31) | decrease in FX borrowing by banks (F65) |
| FX regulations (F31) | increase in FX debt issuance by firms (G15) |
| FX regulations (F31) | decrease in bank exposure to currency fluctuations (F33) |