The views expressed in this presentation are the views of the author and do not necessarily reflect the

views or policies of the Asian Development Bank

Institute (ADBI), the Asian Development Bank (ADB), its Board of Directors, or the governments they represent. ADBI does not guarantee the accuracy
of the data included in this paper and accepts no responsibility for any consequences of their use. Terminology used may not necessarily be consistent
with ADB official terms.
ABDI 19th Annual Conference,
Tokyo,
1-2 Dec 2016

Divergent Monetary Policies and International Dollar Credit-

Evidence from bank-level data

Dong He*, Eric Wong#, Kelvin Ho#, Andrew Tsang#

*International Monetary Fund

and
#Hong Kong Monetary Authority
The views and analysis expressed in this presentation are those of the authors, and do not necessarily
reflect those of the International Monetary Fund or the Hong Kong Monetary Authority
 This study

US dollar international claims

How USD liquidity through the bank lending

channel would be affected by

(1) Monetary normalisation by the Fed

(2) B/S expansion of ECB and BOJ
(3) FX swap costs
(4) Default risk of banks

Source: BIS locational banking statistics (by nationality).

2
 Main Findings
 Tail risk estimates (<10% of chance to occur)
 A significant drop in the supply of international dollar credit:

FX swap Bank default Net impact of

Fed ECB and BOJ cost  risk  divergent MPs
Supply of
+ + + =
International
dollar credit

3
 A theoretical framework

• Modified from Ivashina et al. (2015)

• Assuming a global bank e.g. euro-area bank
• It provides euro € and US$ loans
• It takes no FX risks

4
 A theoretical framework

• $ Funding from the US

Costly $ funding with a Banks to pay a risk

F*
rising marginal cost; and premium p

Costless $ funding
D* (exogenous)

5
 A theoretical framework

• $ Funding from the FX swap market

Costly € funding with a

F rising marginal cost; and
Pay a swap
cost w to
convert € into $
Costless € funding
D (exogenous)

6
 Model prediction

Factors determining international dollar credit (L*) Model predictions

More abundant liquidity in home country (↑D) ↑L*
More abundant liquidity in the US (↑D*) ↑L*
Higher default risk of banks (↑p) ↓L*
Rises in the swap cost (↑w) ↓L*

7
Empirical analysis

8
 Data

• Confidential dataset from HKMA

• 37 non-US foreign bank branches in Hong Kong
• Quarterly growth of US$ loans to more than 70
destination countries i by global bank j (L*ijt)
• From 2007Q1 to 2014Q2

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 Baseline model

L*ijt = 1HCBjt+ D
2FEDt *USFj+ D*
3CDSjt+ p
4CIPjt-1+ w
5GDPjt +
it+ Destination country-time fixed effects to
ijt control for changes in demand for $
loans. Khwaja and Mian (2006)

10
 Extended models (B/S factors of banks)

L*ijt = 1HCBjt+ D
(2+1BSFjt) FEDt *USFj+ D*
3CDSjt+ p
4CIPjt-1+ w
5GDPjt +
it+ Destination country-time fixed effects to
ijt control for changes in demand for $
loans. Khwaja and Mian (2006)

11
 Estimation results

Model Model 1 Model 2 Model 3 Model 4

Base case with a crisis dummy with parents' Full model
for ∆CIPj,t-1 characteristics
∆HCBjt 0.30 ** 0.31 ** 0.31 ** 0.32 **
(2.48) (2.52) (2.33) (2.25)
∆FEDt*USFj 3.15 * 3.05 * 6.53 *** 10.40 ***
(1.70) (1.73) (3.48) (3.77)
∆CDSjt -9.13 ** -9.42 *** -9.73 ** -10.10 **
(-2.71) (-2.85) (-2.54) (-2.55)
∆CIPjt-1 0.88 4.78 5.38 4.99
(0.34) (1.38) (1.57) (1.41)
∆CIPjt-1*Dum(Crisis)t -13.42 * -13.60 ** -12.75 *
(-2.02) (-2.03) (-1.88)
∆GDPjt -0.31 -0.33 -0.51 -0.42
(-0.78) (-0.84) (-1.25) (-1.29)

For brevity, estimated coefficients on BSF and control variables are omitted
Country-time fixed effects for destination country i
Yes Yes Yes Yes
R-squared 0.2802 0.2811 0.2830 0.2881
RMSE 0.4414 0.4413 0.4477 0.4465
No. of observations 2,637 2,637 2,547 2,547

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 The net impact of divergent MPs

• Empirical challenges
– HCBjt and FEDt are exogenous shocks of central bank
balance sheet policy (BSP)

– CDSjt and CIPjt-1 may be responsive to central bank

BSP

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 The net impact of divergent MPs

• VAR models
– Two models: US-euro area and US-JP
– Ten variables, e.g. US-JP
– US: {∆𝑦𝑡𝑈𝑆 ,∆𝜋𝑡𝑈𝑆 ,∆𝑉𝐼𝑋𝑡 ,∆𝐹𝐸𝐷𝑡 }
𝐽𝑃 𝐽𝑃 𝐽𝑃 𝐽𝑃 𝐽𝑃 𝐽𝑃
– JP: {∆𝑦𝑡 ,∆𝜋𝑡 ,∆𝐶𝐼𝑃𝑡 ,∆𝐶𝐷𝑆𝑡 , ∆𝐸𝑋𝑅𝑡 ,∆𝐻𝐶𝐵𝑡 }
– Monthly data from August 2007 to December 2015
– Block exogeneity restrictions (relaxed later)
– Recursive identification scheme

14
 The net impact of divergent MPs

• Central bank BSP shock, US

One annualised S.D
shock: 14.4%;
actual: 26.1%

15
 The net impact of divergent MPs

• Central bank BSP shock, JP

One annualised S.D
shock: 6.3%;
actual: 18.3%

16
 The net impact of divergent MPs

• Central bank BSP shock, euro-area

One annualised S.D
shock: 8.5%;
actual: 13.3%

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 MC simulation to obtain tail risk estimates

• Procedures
– 12-month divergent central bank BSP shock
– Innovation terms for FEDt are calibrated to -1
annualised S.D. for US (i.e. -14.4%);
– Innovation terms for HCBjt are calibrated to +1
annualised S.D. (i.e. 6.3% for JP and 8.5% for euro-area)
– Innovation terms for other variables are obtained by MC
simulations.
– 10,000 sets of {FEDt , HCBjt , CDSjt , CIPjt-1}
– Sufficient to estimate the contribution to L*ijt

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 MC simulation to obtain tail risk estimates

• Tail risk estimates

– Obtained 10,000 trials of L*ijt and estimated
contribution of 4 factors
– Focusing the 10% trails that have lowest credit growth
– Based on the 10% trails to compute the average
contribution of the factors.

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 Tail risk estimates (Japanese branches in HK)

Contribution to the ∆FEDt*USFj ∆HCBjt ∆CDSjt ∆CIPjt-1 ∆Loanijt

growth of Japanese
(%) (%) (%) (%) (%)
banks’ dollar loans
Tail risk estimate -3.3 3.5 -4.6 -4.2 -8.6

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 Tail risk estimates (euro-area branches in HK)

Contribution to the ∆FEDt*USFj ∆HCBjt ∆CDSjt ∆CIPjt-1 ∆Loanijt

growth of euro-area
(%) (%) (%) (%) (%)
banks’ dollar loans
Tail risk estimate -0.3 5.6 -4.4 -5.1 -4.2

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 Robustness checks

1. Using BIS aggregate dataset

2. Inclusion US bank branches in the estimation samples
3. Inclusion policy rates in the VAR models
4. Inclusion shadow policy rates in the VAR models
5. Relaxing block exogeneity restrictions in the VAR
models

22
 Robustness checks (estimated using BIS dataset)

Tail risk estimates ∆FEDt*USFj ∆HCBjt ∆CDSjt ∆CIPjt-1 ∆Loanijt

(%) (%) (%) (%) (%)

Japanese banks -15.2 4.3 -0.6 -13.5 -25.1

Euro-area banks -2.5 8.1 -4.0 -15.2 -13.5

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 Robustness checks
Tail risk estimates ∆FEDt*USFj ∆HCBjt ∆CDSjt ∆CIPjt-1 ∆Loanijt

(%) (%) (%) (%) (%)

Panel A (inclusion of US bank branches for estimating equation (1))

Japanese banks -4.3 2.4 -1.8 -5.0 -8.6

euro-area banks -1.8 4.9 -3.9 -4.1 -4.9

Panel B (inclusion of policy rates in the VAR models)

Japanese banks -3.4 3.3 -4.0 -5.1 -9.2

euro-area banks -2.0 5.4 -9.0 -4.7 -10.2

Panel C (inclusion of shadow policy rates in the VAR models)

Japanese banks -2.9 4.6 -4.2 -4.2 -6.7

euro-area banks -1.8 4.3 -9.1 -4.6 -11.1

Panel D (relaxing block exogeneity restrictions in the VAR models)

Japanese banks -0.4 6.4 -4.8 -5.3 -4.2

euro-area banks -2.8 4.8 -5.5 -5.1 -8.6

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 Conclusion

• The contractionary effect of US monetary normalisation on

global liquidity would be offset by an expansionary effect
from continued supply of US dollar loans from euro-area
and Japanese banks.

• However, there is tail risk that the supply of international US

dollar loans declines especially as the US monetary
normalisation triggers sharp declines in liquidity in the FX
swap market and rises in bank default risks.

25