The Impact of Exchange and Inflation Rate Instability on Lending Behavior of Iranian Banks

Exchange rate instability brings about significant changes in the domestic and foreign sectors that can impose negative effects on the whole economy. The present study investigates the effect of exchange and inflation rate instability on the lending behavior of Iranian banks by using data of the 10 banks over the time period 1382-1397(2003-2018). To do this, at first, a GARCH(1,1) of the exchange and inflation rate is estimated. Then, as an index of instability, its effect on bank’s lending behavior is examined, using the panel data method. The results indicate that the exchange rate instability has a significant negative effect on the lending behavior of Iranian banks. In other words, as the exchange rate instability increases, the banks decrease their loans, due to the fall of the expected return of loans and a higher probability of non-performing loans. Instead, they invest in safe assets with certainly expected returns. Also, instability of inflation rate, business cycle index, and credit quality index has significant positive effects on the lending behavior of banks. In fact, comparing the impact of exchange rate instability on banks lending behavior with other factors shows that banks pay more attention to exchange rate fluctuations compared to fluctuations of other factors in their investment decisions.