Information Asymmetry and Foreign Currency Borrowing by Small Firms

Abstract

We model the choice of loan currency in a framework which features a trade-off between lower cost of debt and the risk of firm-level distress costs. Under perfect information foreign currency funds come at a lower interest rate, all foreign currency earners as well as those local currency earners with high revenues and/or low distress costs choose foreign currency loans. When the banks have imperfect information on the currency and level of firm revenues, even more local earners switch to foreign currency loans, as they do not bear the full cost of the corresponding credit risk.

Foreign Currency Loans and Systemic Risk in Europe

“…Brown, Kirschenmann, and Ongena (2011), on the other hand, study loan application and approval data at a bank in Bulgaria; they find that foreign currency borrowing may be partly supply driven by banks hesitant to give longterm loans in the local currency. 14 Furthermore, Brown, Ongena, and Yeşin (2013) show in a simple banking model that persistent violation of the uncovered interest parity may lead to more foreign currency borrowing in equilibrium if the banks have imperfect information about the revenue level and currency of borrowing firms. Similarly, Degryse et al (2012) find that foreign banks that entered the emerging markets through greenfield investment tend to extend more loans in foreign currency, possibly because of their easier access to foreign currency funding in international money markets.…”

Bank Funding, Securitization, and Loan Terms: Evidence from Foreign Currency Lending

“…The incentive to take foreign currency loans is weaker when the volatility of the exchange rate is higher, as this increases the default risk on unhedged loans. Brown, Ongena, and Yesin () argue that firms with low leverage will be more likely to borrow in foreign currency while information asymmetries about a firm's income structure may increase foreign currency loan demand among unhedged firms…”

“…Brown, Ongena, and Yesin () show that in the case when lenders are imperfectly informed about the currency or level of firm revenue (Berger and Udell ; Detragiache, Tressel, and Gupta ; Brown, Jappelli, and Pagano ), local currency earners may be more likely to choose foreign currency loans.…”

Bank Funding, Securitization and Loan Terms: Evidence from Foreign Currency Lending

“…The incentive to take foreign currency loans is weaker when the volatility of the exchange rate is higher, as this increases the default risk on unhedged loans. Brown, Ongena and Yesin (2013) argue that firms with low leverage will be 14 more likely to borrow in foreign currency while information asymmetries about a firm's income structure may increase foreign currency loan demand among unhedged firms.…”