Dollar funding and the lending behavior of the global banks
By: Victoria Ivashina, David S. Scharfstein, Jeremy C. Stein
Contributors: Scharfstein, David S.; Harvard Business School
Series: Working paper / Harvard Business School -- 13-059; Working paper (Harvard Business School) -- 13-059
Publisher: Harvard Business School
Published: 2012
Place of publication: Boston ]
Language: eng
Number of pages: 45
Description: A large share of dollar-denominated lending is done by non-U.S. banks, particularly European banks. We present a model in which such banks cut dollar lending more than euro lending in response to a shock to their credit quality. Because these banks rely on wholesale dollar funding, while raising more of their euro funding through insured retail deposits, the shock leads to a greater withdrawal of dollar funding. Banks can borrow in euros and swap into dollars to make up for the dollar shortfall, but this may lead to violations of covered interest parity (CIP) when there is limited capital to take the other side of the swap trade. In this case, synthetic dollar borrowing becomes expensive, which causes cuts in dollar lending. We test the model in the context of the Eurozone sovereign crisis, which escalated in the second half of 2011 and resulted in U.S. money-market funds sharply reducing the funding provided to European banks. Coincident with the contraction in dollar funding, there were significant violations of euro-dollar CIP. Moreover, dollar lending by Eurozone banks fell relative to their euro lending in both the U.S. and Europe; this was not the case for U.S. global banks. Finally, European banks that were more reliant on money funds experienced bigger declines in dollar lending.
Notes: "October 2012" -- Publisher's website.

Includes bibliographical references (pages 31-32).