Financial dollarization in emerging market and transition economies

The dollarization of bank deposits and loans is widespread in emerging market and transition economies. Since levels of dollar deposits and loans vary widely across countries and over time, and dollarization is generally associated with potential costs, the causes and economic consequences of financial dollarization deserve thorough analysis.; This dissertation (1) examines the sources of dollarization of bank credit, (2) evaluates the economic effects of policy measures that attempt to restrict dollarization, and (3) assesses the effects of the regulation of foreign exchange and capital transactions on financial intermediation and capital outflows.; The first chapter, “Credit Dollarization, Bank Currency Matching, and Real Activity” models the link between financial dollarization and integration in the international goods market. This chapter develops a general equilibrium model of a small open economy with costly banking and firms that use both domestic currency and dollar loans to finance production. Dollar loans are used to pay for a foreign intermediate good, hence the link to economic integration. Credit dollarization in equilibrium depends on the characteristics of the production process and the relative returns on domestic currency and dollar instruments. Moreover, deposit dollarization can cause credit dollarization, as banks match by currency their deposits and loans. Finally, this chapter shows that policies that attempt to reduce dollarization will cause financial disintermediation.; To date, the contributions of firms and banks to the dollarization of credit remain relatively unexplained. The second chapter, “ Credit Dollarization: Is It Firms' or Banks' “Fault”?”, based on joint work with Iva Petrova, is an empirical study of credit dollarization in transition economies. It separates the respective contributions of banks and firms to the dollarization process by grouping potential determinants into bank- and firm-specific (financial and mainly real) factors. Empirical results provide evidence that bank currency matching is the main driving force of credit dollarization. In addition, there is limited evidence that real dollarization causes financial dollarization. However, currency mismatches tend to be concentrated in the real sector.; The third chapter, “Regulation, Financial Development, and Capital Flows”, evaluates the effects of regulation of foreign exchange and capital transactions on the domestic and international activities of banks. It separates the effects of foreign exchange liberalization from capital outflows liberalization. Will banks provide more domestic credit and “go abroad” less when allowed to freely lend in dollars domestically? Empirical results provide evidence that the liberalization of foreign exchange operations increases the level of domestic credit. Surprisingly, the liberalization of domestic lending in dollars also increases banks' holdings of foreign assets. In addition, banks increase their holdings of foreign assets when capital outflows are liberalized.