book

Understanding Dollarization

by Emre Ozsoz, Erick W. Rengifo

May 2016

Intermediate to advanced

139 pages

4h 2m

English

De Gruyter Oldenbourg

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1.1 Introduction1.2 Asset vs Currency Substitution1.3 Official and Partial Dollarization1.4 Measuring the Degree of Partial Dollarization1.5 Causes of Dollarization1.6 Dollarization and Banking Dollarization1.7 A Brief History of Dollarization Around the Globe1.7.1 Latin America1.7.2 Transition Economies1.7.3 Asia1.7.4 Sub-Saharan Africa1.8 Exchange Rate Regimes and Dollarization
2.1 Introduction2.2 Arguments in Favor of Dollarization2.2.1 Inflation Reduction2.2.2 Fiscal Discipline2.2.3 Reduction in the Cost of Borrowing2.2.4 Lower Transaction Costs2.3 Benefits of Partial Dollarization2.3.1 Encourages Saving2.3.2 Promotes Financial Deepening2.4 Arguments Against Dollarization2.4.1 Costs of Dollarization under Full Dollarization2.4.1.1 Loss of Monetary Policy2.4.1.2 Inability to Act as a Lender of Last Resort2.4.2 Costs of Dollarization under Partial Dollarization2.4.2.1 Increased Foreign Exchange Rate Risk for the Banking System2.4.2.2 Mismatch of Foreign Currency Assets and Liabilities2.4.2.3 Increased Default Risk2.4.2.4 Monetary Policy Challenges
3.1 Introduction3.2 Inflation and Dollarization3.3 Transmission Mechanisms3.3.1 The Trade Channel3.3.2 The Credit Channel3.3.3 Liability Channel3.3.4 Evidence on Currency Substitution Theory3.4 De-Dollarization Hysteresis3.5 New Ideas3.5.1 Inflation in Collective Memory3.5.2 Minimum Variance Portfolio (MVP) Theory3.5.2.1 The MVP Model3.5.2.2 Evidence that Supports the MVP Theory3.5.3 Institutions Argument
4.1 Introduction4.2 Why Do Governments Allow Foreign Currency Accounts and Foreign Currency Lending in the Banking System?4.3 Banking Risks in a Partially Dollarized Economy4.3.1 Currency Mismatch Risk4.3.2 From Currency Mismatch Risk to Default Risk4.4 Empirical Evidence

5.1 Introduction5.2 What We Know about Financial Depth and Dollarization: A Review5.3 Financial Inclusion5.4 Bitcoin: The New Future Form of Dollarization?
6.1 Introduction6.2 Monetary Policy in Partially Dollarized Economies6.3 Regulatory Attitudes Toward Dollarization in the Aftermath of the Financial Crisis6.4 Case Study: Turkey

Overview

A very commonly observed phenomenon in developing and emerging market economies is the use of another country’s currency (whether the US dollar or another currency) in lieu or in addition to the local currency. The most common type of this financial phenomenon is partial (de facto) dollarization where foreign currencies are used side by side with local currency for saving and borrowing purposes in addition to serving as medium of exchange.

Governments in these countries have been encouraging dollarization for years by allowing their citizens to save and borrow from local banks in foreign currency. Yet the existence of multiple currencies on banks' balance sheets on both the asset and liability side poses risks to the health and stability of the banking system.

This book evaluates the practical aspects of partial dollarization in countries such as Turkey, South Korea, Peru, and Cambodia among others. Starting with the origins of the phenomenon, the impact on banking systems and financial depth of the credit markets are discussed along with risks to the banking systems. Challenges faced by Central Banks and banking regulators are evaluated using recent country studies.