Bank Cost Efficiency and Credit Market Structure Under a Volatile Exchange Rate

We study the differential impact of exchange rate volatility on cost efficiency and market structure when banks have non-trivial exposures to foreign currency operations. First, we document that cost efficiency estimates are both severely downward biased by 30% on average and generally not rank preserving when these quarterly revaluations are ignored. Second, we show that the revaluations are fueled by a mismatch in the banks' foreign currency holdings, which, in turn, are driven by household deposits in foreign currencies and by instability of the Ruble's exchange rate. Third, we find that the failure to account for the revaluations may lead to the erroneous conclusion that the credit market is inefficient. Finally, to ensure generalizability to other emerging market economies (EMEs), we suggest a two-stage approach that does not rely on our data set but rather employs banks' exposures to foreign currencies and aggregate exchange rate volatility