Monetary Policy and Global Banking 
Foreign ("global") banks play an important role in many countries and use their global balance sheets to respond to local monetary policy. According to the Bank for International Settlements, European and Japanese banks' claims on U.S. nonbank firms as of June 2015 were USD 1.61 and 0.72 trillion, respectively. Foreign banks help originate close to a quarter of all syndicated corporate loans in the United States (DealScan data). Similarly, U.S. banks are important lenders abroad. However, sources and uses of funds are often denominated in different currencies, leading to a foreign exchange (FX) exposure that banks need to hedge. If cross-currency flows are large, the hedging cost increases, diminishing the return on lending in foreign currency.
Given the economic significance of global banks, questions have been raised about their role in the propagation of economic shocks across countries. This paper studies the effect of monetary policy actions in one country on the lending decisions of global banks abroad, in the context of changes in the interest on excess reserves (IOER) rate in six major currency areas between 2000:Q1 and 2015:Q2.
Key Findings
- Banks facing a larger IOER rate differential abroad (vis-à-vis their home country) tend to hold more reserves with the foreign monetary authority funded through an increase in FX hedging activity and its rising cost, as manifested in violations of covered interest rate parity (CIP).
- Banks facing a larger IOER rate differential abroad (vis-à-vis their home country) tend to lend less abroad due to an increase in hedging cost. In aggregate, borrowers exposed to this type of shock from foreign banks are less likely to receive a loan or, if they do, are more likely to receive a smaller loan, than other borrowers.
Implications
The existing academic and policy view holds that monetary policy in one country has a broad impact on the lending portfolios of multinational banks. The authors of this paper emphasize that use of the internal capital markets in the global setting creates a cross-currency capital flow, which, in turn, can affect banks’ lending decisions via the cost of exchange-risk hedging. These flows are triggered not only by a bank’s desire to smooth monetary policy shocks, but also by the global approach to liquidity management wherein large cross-currency flows would affect the lending of any bank that needs to manage exchange rate risk, hence breaking down the traditional view of the mechanism whereby internal markets operate for the purpose of lending.
In the current economic environment, the cross-currency capital flows might be particularly large and render the proposed mechanism as particularly relevant. First, the large positive interest rate differential between the United States and major foreign countries is relatively recent. Second, the current large amount of excess liquidity in all major currency areas amplifies cross-border movements of liquidity into high-yielding reserves. Third, current global macroeconomic conditions are characterized by a divergence of economic growth between the United States and other major currency areas, in particular the Eurozone and Japan.
Abstract
Global banks use their global balance sheets to respond to local monetary policy. However, sources and uses of funds are often denominated in different currencies. This leads to a foreign exchange (FX) exposure that banks need to hedge. If cross‐currency flows are large, the hedging cost increases, diminishing the return on lending in foreign currency. We show that, in response to domestic monetary policy easing, global banks increase their foreign reserves in currency areas with the highest interest rate, while decreasing lending in these markets. We also find an increase in FX hedging activity and its rising cost, as manifested in violations of covered interest rate parity.