Real Effects of Foreign Exchange Risk Migration: Evidence from Matched Firm-Bank Microdata
Firms that are active in international product and factor markets hedge their exposure to foreign exchange risk by using forward contracts to transfer that risk to banks that are central dealers in the foreign exchange market. This paper identifies this risk migration from firms to the banking sector and the real effects on the German economy in the context of the Brexit referendum in 2016. The authors’ findings show that foreign exchange risk that migrates to the banking sector and is not fully intermediated can have a profound effect on the broader economy. More specifically, imperfect intermediation can result in equity losses at banks, which in turn can lead to a reduction in their credit supply that hampers firms’ ability to borrow and invest and thus triggers a reduction in economic activity.