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Lending and Exchange Rates: The Role of Banks’ Foreign Exchange Position and Hedging Policies

This study delves into the balance sheets of banks and shows that the transmission of exchange rate movements on bank lending is not straightforward but depends on banks’ net open foreign currency (FX) position. A domestic currency depreciation could reduce bank lending and is thus contractionary if banks are in a negative net open FX position, but could increase bank lending and is thus expansionary if banks are in a positive net open FX position. Using the case of the Philippine banking system, results of this study show that a depreciation of the domestic currency by itself and a positive net open FX position alone each tends to lower lending growth. However, for banks with positive net open FX position, there is evidence that depreciations prompt them to increase lending. Thus, a domestic currency depreciation could amplify instead of offset the trade channel. Moreover, hedging instruments appear to dampen the adverse effects of depreciation on bank lending.


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