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| Does Exchange Rate Exposure Affect Firms' Loan Interest Rates？ Evidence from Chinese Listed Companies |
| HE Qing, LIU Erzhuo
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School of Finance, Remin University of China, Beijing;
School of Public Finance and Taxation, Capital University of Economics and Business Beijing |
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Abstract Since the 2005 reform, the RMB exchange rate has been market-oriented, fluctuating in a wide band against the world's major currencies. The “8·11 Exchange Rate Reform” of 2015 streamlined the RMB mid-price mechanism further, switching the RMB/USD exchange rate from one-way to two-way movement, so that the market now plays a decisive role in the RMB exchange rate. The RMB exchange rate is more elastic at a reasonable equilibrium level. As the RMB exchange rate has become more flexible, the impact of RMB exchange rate fluctuations on firms' performance has grown. Especially in recent years, because of increased trade frictions between China and the U.S., RMB exchange rate fluctuations have increased. Chinese enterprises have become increasingly sensitive to exchange rate risk, a material factor affecting their operations (He et al., 2021a). Thus, it is critical to mitigate the adverse impact of exchange rate risk on businesses.
In a bank-dominated financial system, Chinese enterprises rely heavily on bank loans for funds. Loan rates directly affect their investment decisions, which in turn affect their performance and long-term competitiveness (He et al., 2017). The importance of loans makes bank credit a major channel through which exchange rate sensitivity affects businesses. However, few scholars have focused on the relationship between exchange rate exposure and business loan rates. Because of rising exchange rate uncertainty and successive reforms of the interest rate system, a full clarification of this relationship will benefit Chinese enterprises in hedging exchange rate risk and financial institutions in pricing the risk.
This paper investigates the impact of exchange rate exposure on business loan interest rates using data from A-share listed companies in China from 2009-2018. The findings show that there is a significant positive correlation between exchange rate exposure and corporate loan interest rates. The positive relationship between negative exchange rate exposure and corporate loan interest rates is stronger than the positive relationship between positive exchange rate exposure and corporate loan interest rates, indicating that corporate loan interest rates better reflect the potential loan default risk associated with exchange rate exposure, particularly negative exchange rate exposure. A moderation effect test shows that the positive relationship between exchange rate exposure and corporate loan interest rates is more significant for companies with higher foreign income, more investment in foreign subsidiaries, and more use of foreign exchange derivatives. This suggests that Chinese companies have poor risk diversification in their foreign operations and may misuse foreign exchange derivatives. The basic findings remain robust to the use of the generalized method of moments estimation (GMM), the inclusion of alternative indicators, and different group regressions.
We further compare the heterogeneity of the relationship between exchange rate exposure and corporate lending rates across different bank-firm relationships, different collateral values, and firms with different shareholder-creditor conflicts of interest to explore the mechanisms by which exchange rate exposure affects corporate lending rates. We find that the positive relationship between exchange rate exposure and corporate loan interest rates is more significant under closer bank-firm relationships and more intense shareholder-creditor conflicts of interest. Under lesser collateral value, the positive relationship between exchange rate exposure and corporate loan interest rate is even stronger.
The contributions of this paper are as follows. First, it is the first to demonstrate the extent and mechanism of the impact of exchange rate exposure on corporate loan interest rates in China. The research results can help commercial banks cope with exchange rate risks, reduce financing costs in the credit market, and guide financial institutions to serve the real economy. Second, this paper explores the mechanism by which exchange rate exposure affects corporate loan interest rates based on the heterogeneity test. Focusing on the U.S. market, Francis and Hunter (2012) explored the relationship between exchange rate exposure and lending rates; however, the influence mechanism remains unclear. Our paper further discusses the moderating effects of firms' foreign operations, investments, and use of foreign exchange derivatives on their exchange rate exposure and lending rates. This paper also uses empirical evidence to explain the mechanism of the effect of exchange rate exposure on loan interest rates from three perspectives: the bank-firm relationship, firms' collateral value, and shareholder-creditor conflict of interest.
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Received: 18 January 2021
Published: 01 September 2022
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