The Risk Associated with Banks` Foreign Borrowing

Abstract

Since 1995 banks’ foreign borrowing has increased sharply, matching the growth recorded in the mid-1980s. Measured in relation to banks’ total loans, foreign funding is smaller now than at that time. As was the case in the mid-1980s, the increase in foreign borrowing came in response to strong demand for domestic NOK loans. In principle, the exchange rate risk associated with borrowing is eliminated inasmuch as banks use the foreign currency loans to buy NOK spot and sell the same volume of NOK forward in the foreign exchange market. Foreign borrowing, however, involves higher liquidity risk than funding from other sources. Liquidity risk increases both because foreign borrowers may react collectively towards Norwegian banks to a greater extent than ordinary Norwegian depositors and because of the possibility of liquidity problems in the forward market where the currency is temporarily exchanged for NOK. The increased magnitude of bond issues since 1997 has contributed to extending the maturity of foreign debt, thereby curbing the increase in liquidity risk.