Foreign currency borrowing, balance sheet shocks and real outcomes

BIS Working Papers  |  No 758  | 
22 November 2018



A negative shock to a firm's balance sheet can impair the firm's borrowing and investment. Especially in emerging market economies, firms are vulnerable to such shocks through a currency depreciation when they borrow in foreign currency. This paper studies such balance sheet effects using a unique data set of firms in Mexico. The data include detailed information on loans from each bank and the foreign currency on firms' balance sheets, and cover a period with a large depreciation.


Firm balance sheet effects may play a large role in generating or amplifying financial stress. However, effects can occur at the same time as negative shocks occur to bank lending or to demand from firms. This makes it difficult to tell if a change in firms' outcomes is due to the balance sheet shock or other factors. Using the information on how much each firm borrows from each bank, the paper isolates changes in borrowing and investment due to firms' balance sheet shocks from those changes arising from how much the banks lend generally as well as from other potential factors.


Balance sheet effects do affect a firm's borrowing and investment. Firms undergoing a negative shock due to a currency depreciation experience a decrease in their borrowing in foreign currency. Larger firms, however, are able to replace the lost funding by borrowing in their domestic currency, whereas smaller firms cannot. These differences affect real activity: larger firms are able to increase investment and employment following a depreciation, while smaller firms decrease their investment.

These results imply that the health of the firm's balance sheet constrains its ability to borrow. This constraint is tighter for foreign currency borrowing and looser for larger firms.



Emerging market firms frequently borrow in foreign currency (FX), but their assets are often denominated in domestic currency. This behavior leads to an FX mismatch on firms balance sheets, which can harm their net worth in the event of a depreciation. I use a large, unanticipated, and exogenous depreciation episode and a unique dataset to identify the real and financial effects of firm balance sheet shocks. I construct a new dataset of all listed non-financial firms, matched to their banks, in Mexico over 2008q1-2015q2. This dataset combines firm-level balance sheets and real outcomes, currency composition of both assets and liabilities, and firms' loan-level borrowing from banks in peso and FX. This data allows me to control for shocks to firms' credit supply to identify the balance sheet shock and examine its real consequences. I find that non-exporting firms that have a larger FX mismatch experience greater negative balance sheet effects following the depreciation. Among these, smaller firms see a decrease in loan growth, resulting in stagnant employment growth and decreased growth in physical capital relative to firms with smaller FX mismatch. Larger firms with a large FX mismatch also have lower growth in FX loans following the shock, but are able to increase borrowing in peso loans, resulting in relatively higher growth in employment and physical capital. My results imply that firms are subject to net worth based borrowing constraints, and that these constraints are more binding on smaller firms and for loans in FX.

JEL classification: E44, F31, F41, F44, G31, G32

Keywords: balance sheet shocks, credit rationing, currency risk, foreign currency, corporate finance, bank lending, investment