XXV Edition

1-2 December 2016"

Banks' Leverage Procyclicality: does Currency Diversification Matter?

Pedrono Justine, Center for International Perspective Studies (CEPII)
Aurélien Violon, Bank of France

Assets of banks located in France are mainly denominated in euro and in US dollar. Currency diversification, which measures how much of assets are denominated in US dollar, implies a diversification of the credit risk and a valuation effect due to foreign exchange rate. Hence, it changes banks' debt capacity and their resilience to economic shocks. Thereby, currency diversification of assets affects leverage responsiveness to the value of assets, namely the leverage procyclicality. Using innovative data on credit institutions located in France between 1999 and 2014, we analyze whether currency diversification of assets affects leverage procyclicality. Focusing on investment banks and US dollar diversification, our analysis supports theoretical results. Currency diversification reduces leverage procyclicality through credit risk diversification but it raises leverage procyclicality through the valuation channel of the exchange rate. Additionally, our results confirm the theoretical prediction where currency mismatch does not affect leverage procyclicality.

Area: Young Economists Session (YES award)

Keywords: banks, procyclical leverage, currency diversification, currency mismatch, financial accelerator

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