Highlights :

• A significant part of banks’ balance sheet is diversified in terms of currency: on average 22% of total assets of banks located in France are denominated in USD in the period 1999-2015. The US dollar is the first foreign currency with 19% of total assets denominated in USD on average.
• Currency diversification reduces leverage procyclicality through credit risk diversification but it raises leverage procyclicality through the valuation channel of the exchange rate. Focusing on investment banks, the valuation effect dominates.
• As leverage procyclicality is mainly driven by the value of assets, currency mismatch is not determinant in theory. Our results confirm this theoretical prediction where a currency mismatch does not strongly affect leverage procyclicality.
• As currency diversification affects leverage procyclicality, our conclusions support the idea that currency diversification is an interesting candidate for micro and macro-prudential policy.

 Abstract :
Currency diversification, which measures how much of assets are denominated in foreign currency, introduces a credit risk diversification and a valuation effect due to fluctuations of exchange rate. It affects banks' leverage responsiveness to the value of assets, namely the leverage procyclicality. Using novel micro data on banks' exposures, we confront theoretical conclusions by focusing on the US dollar diversification of banks located in France between 1999 and 2015. Distinguishing between commercial and investment banks, our analysis first supports previous empirical results where investment banks are more pro-cyclical than commercial banks. Second, our results show that the largest pro-cyclicality of investment banks comes from the effect of currency diversification, especially from the valuation effect of currency diversification which increases procyclicality. Finally, our results confirm the theoretical prediction where a currency mismatch does not strongly affect leverage procyclicality. Our conclusions support the idea that currency diversification is relevant to micro and especially macro-prudential policy.

 Keywords : banks | procyclicality | exchange rate | diversification | balance sheet | financial cycle | financial intermediaries

 JEL : F3, F4, G15