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Hedger of Last Resort: Evidence from Brazilian FX Interventions, Local Credit and Global Financial Cycles

Summary:
BIS Working Papers  |  No 832  |  18 December 2019 by  Rodrigo Barbone Gonzalez, Dmitry Khametshin, Jose-Luis Peydro and Andrea Polo PDF full text (506kb)  |  50 pages Focus We analyse whether the global financial cycle affects credit supply in Brazil, its related real effects, and whether local unconventional policies can attenuate such spillovers. After the announcement of the tapering of US quantitative easing by Federal Reserve Chairman Ben Bernanke in May 2013, domestic banks with a greater reliance on foreign debt reduced the

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BIS Working Papers  |  No 832  | 
18 December 2019
PDF full text
 (506kb)
 |  50 pages

Focus

We analyse whether the global financial cycle affects credit supply in Brazil, its related real effects, and whether local unconventional policies can attenuate such spillovers. After the announcement of the tapering of US quantitative easing by Federal Reserve Chairman Ben Bernanke in May 2013, domestic banks with a greater reliance on foreign debt reduced the supply of credit to firms in local currency, which in turn lowered employment. However, the Central Bank of Brazil (BCB) attenuated these negative effects by announcing a large intervention programme in the FX derivatives market, consisting in providing insurance against FX risks - hedger of last resort.

Contribution

There is a large literature exploring the lending channel in emerging market economies and its dependence on global financial conditions. However, that literature does not evaluate how local unconventional policies, such as FX interventions, can attenuate the effects of the global financial cycle on local credit markets and on the overall economy. A growing literature on FX interventions has focused on sterilised FX interventions. The evidence on the effectiveness of these tools is a source of controversy, though. In this paper, we use micro-data from Brazil and focus on a different form of intervention using FX derivatives and find a potent channel that directly affects domestic banks, with related effects on firms' credit intake and labour demand.

Findings

For identification, we exploit global financial cycle shocks, the differential reliance of domestic banks on foreign debt, and central bank interventions in FX derivatives using three matched administrative registers: the register of foreign credit flows to banks, the credit register, and a matched employer-employee database. We find that banks with larger foreign debt liabilities contracted credit supply following the "taper tantrum", which tightened financial conditions for firms more dependent on these banks for funding, with related implications for firms' labour demand. After these events, the BCB intervention programme halved these effects. In addition to exploring these two subsequent shocks in a difference-in-difference strategy, we analyse a panel over 2008-15 and find a broader channel: banks with larger foreign debt responded to US dollar appreciation, increased FX volatility, and tighter US monetary policy by decreasing credit supply. FX interventions mitigated these effects of the global financial cycle on credit, confirming that policies promoting the supply of hedging instruments are effective in decreasing local economy exposure to global conditions.


Abstract

Bail-in regulation is a centrepiece of the post-crisis overhaul of bank resolution. It requires major banks to maintain a sufficient amount of "bail-in debt" that can absorb losses during resolution. If resolution regimes are credible, investors in bail-in debt should have a strong incentive to monitor banks and price bail-in risk. We study the pricing of senior bail-in bonds to evaluate whether this is the case. We identify the bail-in risk premium by matching these bonds with comparable senior bonds that are issued by the same banking group but are not subject to bail-in risk. The premium is higher for riskier issuers, consistent with the notion that bond investors exert market discipline on banks. Yet the premium varies pro-cyclically: a decline in marketwide credit risk lowers the bail-in risk premium for all banks, with the compression much stronger for riskier issuers. Banks, in turn, time their bail-in bond issuance to take advantage of periods of low premia.

JEL codes: E5, F3, G01, G21, G28

Keywords: foreign exchange, monetary policy, central bank, bank credit, hedging

International Settlement
The Bank for International Settlements (BIS) is an international company limited by shares owned by central banks which "fosters international monetary and financial cooperation and serves as a bank for central banks". The BIS carries out its work through subcommittees, the secretariats it hosts and through an annual general meeting of all member banks. It also provides banking services, but only to central banks and other international organizations. It is based in Basel, Switzerland, with representative offices in Hong Kong and Mexico City.

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