Liquidity Shocks, Dollar Funding Costs, and the Bank Lending Channel During the European Sovereign Crisis

Abstract

This paper documents a new type of cross-border bank lending channel using a novel dataset on the balance sheets of U.S. branches of foreign banks and their syndicated loans. We show that: (1) The U.S. branches of euro-area banks suffered a liquidity shock in the form of reduced access to large time deposits during the European sovereign debt crisis in 2011. The shock was related to their euro-area affiliation rather than to country- or bank-specific characteristics. (2) The affected branches received additional funding from their parent banks, but not enough to offset the lost deposits. (3) The liquidity shock prompted branches to cut lending to U.S. firms, which occurred mostly along the extensive margin. In turn, the affected U.S. firms suffered reduced access to syndicated loans, which prompted them to cut investment and built up their cash reserves.

Keywords: Sovereign risk, international banking, money market funds, liquidity management.

JEL Classification: F34, G15, G21