Macro-prudential rules targeting foreign exchange may achieve their primary objectives, but simultaneously shift problems elsewhere, according to a recent Bank of England working paper.
Toni Ahnert, Kristin Forbes, Christian Friedrich and Dennis Reinhardt test whether the rules “shift the snowbank” – shovelling risks from one place to another, rather than curbing them outright.
The authors built a model of bank and market funding along the lines proposed by Nobel laureates Bengt Holmstrom and Jean Tirole, but added differentiated lending between domestic and foreign currencies.
The model implies macro-prudential forex regulations are effective in reducing foreign currency borrowing by banks, but have the unintended consequence of causing firms to increase forex debt issuance.
The measures also reduce the sensitivity of banks to exchange rate movements, but have less of an impact on firms and the broader financial market.
“Our results suggest that macro-prudential forex regulations can reduce risks in a systemically important sector of the economy (banks). This needs to be balanced, however, against any increase in risks in other sectors,” the authors say.