A strong dollar has been associated with lower lending to emerging markets and tighter global financial conditions. This paper documents similar patterns for credit in the U.S. economy: when the U.S. broad dollar index appreciates by 1 percent, U.S. banks’ corporate loan originations fall by 4.5 percent, with banks tightening credit standards and lending to safer borrowers. This negative correlation, which we term the U.S. dollar credit channel, is at least in part driven by institutional investors, who reduce their demand for risky loans on the secondary loan market when the dollar appreciates. As it becomes harder to sell loans to these investors, banks lend less.

This paper investigates the validity of banks' credit loss projections in the bi-annual EU-wide bank stress tests, which inform regulatory capital requirements. It finds that banks “re-optimized” their models in 2016 to bring down credit losses, exploiting flexibility in the stress test framework. Specifically, banks whose losses would have increased the most from 2014 to 2016 because of changes in the adverse scenario saw the largest decrease in projected losses thanks to model changes. Upon the release of the 2016 stress test results, stock prices and credit default swap spreads increased more for banks that achieved a greater reduction in credit losses through “re-optimization”, consistent with investors anticipating lower future capital requirements for these banks.