Bank balance sheets and exchange rate regimes in emerging markets

The severe financial crises in developing countries over the past 15 years have either been caused or aggravated by the currency and maturity mismatches in the banking sector balance sheets. This thesis conducts theoretical and empirical analyses of balance sheet effects and their implications for exchange rate regimes.; The first chapter shows that countries characterized by a financial accelerator mechanism may reverse the usual finding of the literature---flexible exchange rate regimes do a worse job of insulating open economies from external shocks. This result follows from a calibrated small open economy model which endogenizes foreign interest rates. In this context, the foreign premium depends positively on the banks' net foreign liabilities and negatively on their net worth. This relationship renders exchange rate policy more important compared to the exogenous interest rate framework followed by the literature. The model's output response to external shocks is smaller under tight regimes. Finally, 2nd order approximation to the theoretical model finds larger welfare losses under flexible regimes.; Empirical support for the theoretical framework is provided in the second chapter. Regression analyses show that there is a negative leverage-emerging market bond spread relationship and that the degree of hedging is relatively small in developing countries. PSVAR methods that use the EMBI instead of advanced country lending rates show that when faced with external shocks, balance sheet effects dominate the effects of involuntary interest rate adjustments under tight regimes. Therefore, contrary to the existing literature, the amplitude of output response is smaller under tight regimes.; Despite the extensive literature on currency mismatches, research on the determinants and effects of maturity mismatches is scarce. The third chapter shows that emerging market banks' maturity mismatches are negatively affected by capital inflows and price volatilities, and that banks with low maturity mismatches are more profitable during crisis periods but less profitable in the absence of crises. The later result implies that banks face a tradeoff between higher returns and risk, and that channeling of short term capital into long term loans is due to cronyism and implicit guarantees rather than the depth of the financial market.