Global Banks' Leverage and its Macroeconomic Effects

Abstract

This paper develops a tractable multi-country model of the international banking system and shows that a country’s net external position against global banks -its assets on global banks minus its liabilities towards global banks- plays a key role in explaining its macroeconomic response to a change in global financial conditions. Countries with higher net external liabilities against global banks tend to experience a larger drop in their current account balance and in their risky asset prices, and a larger depreciation of their exchange rate following a deleveraging by global banks. The main predictions of the model are borne out in the data.