Today, a large share of
USD lending is done by non-US banks. As explained by Victoria
Ivashina, David S. Scharfstein, and Jeremy C. Stein in a recent FRB
research paper (See below), this lending activity can be refinanced
in three ways:
- Retail USD funding: The foreign bank collects insured deposits in the US.
- Wholesale USD funding: The foreign bank gathers uninsured and unsecured money market funds’ investments.
- Synthetic USD funding: Initially, the foreign bank raises funds in local currency in its home country, through insured retail deposits. As a second step, it swaps these funds in USD via FX markets. Finally, the bank covers its USD exposure by selling USD forward for Euro.
In practice, wholesale
USD funding prevails. This funding method has the consequence that
the foreign bank’s USD lending becomes vulnerable to a (perceived)
decline of its creditworthiness.
As a matter of fact,
money market funds will cut back their exposure vis-à-vis the
foreign bank in question. This is what actually happened in 2011 to
European banks as a consequence of the expanding crisis in the
Eurozone.
At the same time, the
bank’s retail funding in its home market remains unaffected, due to
a better reputation in its home market and, above all, the home
country’s public deposit insurance in place. In theory, the foreign
bank should, therefore, shift to synthetic funding to make up for the
shortfall of its wholesale USD funding.
However, in practice,
synthetic USD funding turns out to be more expensive than wholesale
USD funding. As the authors explain in their paper, this is due to a
violation of the covered interest parity (CIP).
As a matter of fact, if
interest rate parity holds, the USD forward price would only depend
on the interest differential:
F (t) = S (0) * [(1 +
iDomestic Currency) / (1
+ iForeign Currency)]
with
F
(t) = the forward exchange rate for the maturity t
S
(0) = the current spot exchange rate
iDomestic Currency
= the domestic interest rate on financial securities with maturity t
iForeign
Currency = the
foreign interest rate on financial securities with maturity t
However, this
relationship will be affected negatively by a large surge in demand
for FX forwards and by a limited capacity on the part of arbitrageurs
to post collateral related to such forwards.
As a consequence, USD
lending by the foreign bank will decline, relative to its home
currency lending.
Data
To better understand the
context of the above discussion, I have gathered some data. A a
caveat, the data below does not always relate specifically to USD
Lending. However, it still gives a good overview over the
issues at hand.
Until the financial
crisis, European banks have substantially increased their external
asset positions. Recently, the Lehman Brothers’ bankruptcy and the
Eurozone crisis have lead to a 24 % decrease of such exposure.
As a matter of fact, US
assets and loans of foreign banks are less stable over time, compared
to those of US banks.
This graph shows the
growing importance of foreign banks on the US loan market: The share
of US banks fell from 82 % in 1980 to 66 % in 2012.
This graph shows quite
well the shift of foreign banks' US assets from European banks to
Asian banks.
Resources:
Data:
