Banks' Foreign Currency Exposure and the Real Effects of Exchange Rate Shocks

This paper shows that banks' net foreign currency exposure is an important channel through which exchange rate shocks get transmitted to the real economy. I construct a new dataset on net foreign currency exposures of Swiss banks and exploit the large and unanticipated currency appreciation episode from Switzerland in January 2015 to identify the causal impact of exchange rate shocks on economic activity. I find that the appreciation of the Swiss franc enabled banks with a net foreign currency liability exposure to expand credit supply. Non-financial firms that had a pre-shock relationship with positively affected banks were able to invest more, partially offsetting the negative effects of domestic currency appreciation on exports. At the firm-level, I compare this bank-lending channel with the trade channel and the corporate balance sheet channel and show how exchange rate shocks can have heterogeneous effects on the economy depending on the relative strengths of these channels. Extending my findings to historical currency depreciation episodes over the 1950-2016 period, I provide suggestive evidence that foreign currency exposure of the banking sector can explain the differential response of economic activity to exchange rate shocks across countries. The bank-lending channel of exchange rates can thus explain why currency appreciations are not always contractionary and currency depreciations not always expansionary