Working Paper: NBER ID: w31255
Authors: Kristin Forbes; Christian Friedrich; Dennis Reinhardt
Abstract: This paper explores the relationship between different funding structures—including the source, instrument, currency, and counterparty location of funding—and the extent of financial stress experienced in different countries and sectors during the sharp risk-off shock in early 2020 when Covid-19 spread globally. 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 how different funding structures are related to financial stress. A higher share of funding from non-bank financial institutions (NBFIs) 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) was not significantly related to financial stress. 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 structures; nonbank financial institutions; macroprudential regulation
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) | Greater financial stress in banks (F65) |
| Higher reliance on household deposits (G21) | Less financial stress in banks (G21) |
| Higher reliance on US dollar funding (F65) | Increased financial stress in banks (G21) |
| Type of funding instrument (loans vs. debt markets) (G21) | Resilience (Q54) |
| Geographical location of counterparty (domestic vs. cross-border) (F34) | Resilience (Q54) |
| Targeted policies addressing NBFI and dollar funding vulnerabilities (F65) | Mitigating stress (I31) |