Real Consequences of Shocks to Intermediaries Supplying Corporate Hedging Instruments.

This article investigates the real economic effects of shocks to financial intermediaries supplying foreign exchange derivatives (FXD) used by corporations for hedging, focusing on a 2010 regulatory change in South Korea that imposed capital requirements on banks' FXD positions. Exploiting variation in banks' exposure to this regulation, the study finds that constrained banks reduced their FXD supply, which led to a significant decline in FXD hedging among firms, particularly exporters relying heavily on such instruments. This reduction in hedging caused a substantial decrease in exports for affected firms, especially smaller exporters, as firms strategically lowered their export exposure when hedging became more costly. The research rules out alternative explanations such as speculation or credit supply shocks and highlights the crucial role of financial intermediaries in risk allocation through derivatives, demonstrating a causal link between financial hedging and real economic outcomes. The findings also suggest that macroprudential FX regulations, while aimed at financial stability, can have unintended adverse effects on international trade and the broader economy.