The Real Consequences of Macroprudential FX Regulations

I exploit a natural experiment in South Korea to examine the real effects of macroprudential foreign exchange (FX) regulations designed to reduce risk-taking by financial intermediaries. By using cross-bank variation in the regulation’s tightness, I show that it causes a reduction in the supply of FX derivatives (FXD) and results in a substantial decline in exports for the firms that were heavily relying on FXD hedging. I offer a mechanism in which imbalances in hedging demand, banks’ costly equity financing, and firms’ costly switching of banking relationships play a central role in explaining the empirical findings.