Financial Dollarization,Currency Mismatch And Financial Crisis In Latin America

Since 1990s,a series of financial crisis have burst in Latin America :1994 Mexico'sfinancial crisis, 1999 Brazil's financial disturbance,2001 Argentina's crisis and 2002Uruguay's financial disturbance. The experience in Latin shows that : With the tendency ofeconomic integration and financial liberation ,financial crisis is strongly contagious, thatis ,a crisis in one country will quickly spread to others, and bring great economic lossesconsequently .For the above reasons ,a lot of research has been made on the causes offinancial fragilities in Latin America. A widely consensus is that the pegged exchange rateregime is the fundamental cause of crises. As the research deepens ,many literature findthat financial dollarization ,which is definded as the holding of foreign assets and liabilities bydomestic residents ,is widely spread accorss Latin America .Within the countries that haveexperienced financial crisis, they have been taking on a high degree of financial dollarization.Financial dollarization has then becoming a hot topics.This paper firstly make a definition on finical dollarization , which only refers to assetsubstitution here . Then it analysis the causes of financial dollarization as well as its impact onfinancial crisis. It finds that it is currency mismatch ,caused by financial dollarization ,thatdirectly contributes to the risk of financal crisis of Latin America : a experience of high andvolatile inflation ,which has greatly damaged resident's confidence with domestic currencyand the authorities , is the critical cause of financial dollarization. While ,the high degree offinancial dollarization forced the authority to choose an unsuitable pegged exchange ratearrangement ,which lead to vast currency mismatches for the country .The vast currencymismatches make the agents so sensitive to exchange rate volatility that when the country ishit by negative shocks leading to expectation of depreciation, currency mismatch willgenerate negative balance sheet effects which deteriorate the net worth of the agents andincrease the risk of dollar debtors .For the private companies they will be traped in poorfinance conditions or will disrupt;For the banking sector ,they will suffer liquidity andsolvency crisis;For the government ,they will further loose their confidence by the public. Atlast the expectation and crisis will be self-fulfilling .