Financial Globalization and Bank Lending: The Limits of Domestic Monetary Policy

Jin Cao and Valeriya Dinger

Exploring bank-level data from a small open economy, we present evidence that global funding conditions limit the effectiveness of domestic monetary policy in terms of shaping both the volume and the riskiness of bank lending. We show that more favorable global funding conditions associated with a local currency appreciation encourage banks to increase lending, leverage up, take more risks, and thus insulate themselves from lean-against-the-wind domestic monetary policy. These results support the existence of a risk-taking channel of currency appreciation (Bruno and Shin ((2015a), (2015b)) at the bank level.