Financial Stability in Dollarized Economies

OCCASIONAL PAPER

Financial Stability inDollarized Economies

Anne-Marie Gulde, David Hoelscher,Alain Ize, David Marston, and Gianni D e Nicolo

INTERNATIONAL M O N E T A R Y F U N D

Washington DC

2004

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Contents

Preface v

I Introduction I

II Impl icat ions o f Dollarization for Financial Stability 4Are Dollarized Financial Systems Inherently Vulnerable? 4What Are the Specific Financial Risks of Partial Dollarization? 5

III Managing Bank Runs in Dollarized Countries 12

Provision of Emergency Liquidity 12Depositor Protection 12Administrative Measures 13

IV Prudential Framework for Managing Dollarization Risks 14H o w Are Dollarized Countries Managing Dollarization Risks? 14Is a Regulatory Tightening Needed? 18Agenda for Prudential Reform 19Enhancing the Attractiveness of Local Currency 22Implementation Issues 24

V Conclusions 26

References 27

Boxes1. Dollarization Types and Trends 12. Dollarization Levels Versus Dollarization Risks 23. Systemic Risk Potential and Dollarization 54. Costs and Benefits of N o r m s to Control Liquidity Risk: The Case of Peru 155. Practical Safeguards and Countermeasures for Offshore Financial Centers 24

Tables1. Average Foreign Currency Deposits to Total Deposits 22. Indicators of Domestic Financial Intermediation in Foreign Currency, 2001 33. Deposit Volatility and Dollarization 44. Impact of Dollarization on Financial Soundness Indicators 55. Bank Runs in Partially Dollarized Economies 76. Risk Management Arrangements in Dollarized Economies 167. Creditor Runs in the Peruvian Banking System 18

iii


Figures1. Foreign Currency Deposits 62. Foreign and Local Currency Deposits 83. Interest Rates on Foreign Currency Deposits 94. Deposit and Loan Dollarization 105. Real and Financial Dollarization 106. Dollarization and Volatility of the Bilateral Real Exchange Rate to the

U . S . Dollar, 1990-2001 107. Average Dollarization and Official Reserves to M 2 , 1996-2001 18

The following symbols have been used throughout this paper:

. . . to indicate that data are not available;

— to indicate that the figure is zero or less than half the final digit shown, or that the itemdoes not exist;

- between years or months (e.g., 1998-99 or January-June) to indicate the years ormonths covered, including the beginning and ending years or months;

/ between years (e.g., 1998/99) to indicate a fiscal (financial) year.

"Billion" means a thousand million.

Minor discrepancies between constituent figures and totals are due to rounding.

The term "country," as used in this paper, does not in all cases refer to a territorial entity thatis a state as understood by international law and practice; the term also covers some territorialentities that are not states, but for which statistical data are maintained and provided interna-tionally on a separate and independent basis.

iv

CONTENTS


Prdeface

This Occasional Paper addresses the challenges to prudential supervision in highlydollarized economies where central banks and supervisors m a y be constrained in theuse of standard monetary and financial policy tools. Based on a 2003 I M F ExecutiveBoard Paper, Financial Stability in Dollarized Economies is part of the policy devel-opment work conducted by the IMF's Monetary and Financial Systems Department.Its conclusions are the basis of an ongoing policy dialogue with m e m b e r countries,standard-setters in the financial area, and academia.

The paper is the result of a group effort. It was prepared by Anne-Marie Gulde,David Hoelscher, Alain Ize, David Marston, and Gianni D e Nicolo, with importantcontributions from Socorro Heysen, R . A r m a n d o Morales, and Marina Moretti. Theauthors thank all contributors, internal reviewers, and the various country authoritiesw h o responded to a survey on prudential practices. They are also grateful to KalinTintchev for providing excellent research assistance, Tsegereda Mulatu for expertlycoordinating the preparation of the manuscript, and Archana K u m a r of IMF's ExternalRelations Department for editing the paper and coordinating its publication.

The opinions expressed in the paper are those of the authors and do not necessarilyreflect the views of the national authorities, the I M F , or I M F Executive Directors.

V


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I Introduction

Dollarization, a c o m m o n feature in m a n y devel-oping and transition countries, can have impor-

tant implications for financial stability. In a bid topromote financial intermediation and deepening,m a n y countries around the world have openlyencouraged or accommodated the growth of finan-cial dollarization—the use of a foreign currency,mainly the dollar, to denominate financial contracts.Neither the phenomenon itself nor the specific finan-cial sector risks that m a y be associated with it, suchas the limitations it poses on the central bank'slender-of-last-resort functions or the added con-straints it m a y impose on banks' liquidity manage-ment, are new. However, the recent rapid growth indollarization in m a n y parts of the world (Box 1), theongoing financial crises in several highly dollarizedLatin American countries, and the attendant visibleproblems for some countries' banking systems sug-gest that allowing financial dollarization to spreadmight involve important trade-offs between financialdevelopment and stability.

The main purpose of this paper is to contribute tothe emerging debate regarding an adequate pruden-

tial and crisis management framework for dollarizedeconomies. F r o m a current policy perspective, twoissues deserve particular attention. D o the additionalfinancial sector risks in dollarized countries requireadaptations to the commonly recommended pruden-tial framework, particularly w h e n viewed from a sys-temic perspective? Equally important, in the casewhere a country does face a financial sector crisis, isthe recommended response different for dollarizedcountries? The associated issues in the area of pru-dential oversight have not yet been fully resolveda m o n g economists and supervisors, and no clearguidelines from relevant standard-setting bodies,such as the Basel Committee on Banking Supervi-sion ( B C B S ) , have yet been worked out. Against thisbackground, our preliminary conclusions are in-tended to be first steps that m a y need to be revisitedin the context of further analysis of country experi-ences and more in-depth discussions with supervi-sory and standard-setting bodies.

Dollarization is both a reflection of and has keyimplications for macroeconomic policies, especiallymonetary policy. While this paper recognizes these

Box I. Dollarization Types and Trends

Dollarization can take multiple forms. Official (dejure) dollarization occurs w h e n the U . S . dollar is adopt-ed as the predominant or exclusive legal tender. Partial(de facto) dollarization occurs w h e n the local currencyremains the exclusive legal tender but financial andpayments transactions are allowed to be denominatedin dollars, effectively allowing a bicurrency system totake hold. It is useful, in turn, to distinguish betweenpayments dollarization (the use of foreign currency fortransaction purposes), financial dollarization (resi-dents' holding of financial assets or liabilities in foreigncurrency), and real dollarization (the indexing, for-mally or de facto, of local prices and wages to the dol-lar). Financial dollarization can also be classified asdomestic (e.g., the use of the dollar in claims betweenresidents) or external (e.g., the use of the dollar inclaims between residents and nonresidents). While the

U . S . dollar is by far the dominant currency used inbicurrency systems, other currencies can be (and arebeing) used as complements to the local currency. Theterm "dollarization" should thus be taken in a genericsense.

Partial dollarization affects a wide set of countriesand has increased in recent years. The set of partiallydollarized countries includes a large number of devel-oping, emerging, and transition countries (see Table 1).The ratio of onshore foreign currency deposits to totalonshore deposits increased substantially in Latin A m e r -ica (defined as South America, Mexico, and CentralAmerica) and the transition countries. It has also in-creased, albeit somewhat more moderately, in Africa,Asia, and the Middle East. It remained constant onaverage (and low) only in the Caribbean region and theindustrial countries.

1


Table I. Average Foreign Currency Deposits to Total Deposits(In percent)

two-way linkages, it addresses macroeconomicissues only inasmuch as they have a direct bearingon financial sector stability. Moreover, although thispaper takes a stance on the macroeconomic policiesthat need to accompany an effort to limit the finan-cial vulnerabilities deriving from dollarization, itsmain focus is on h o w to limit these vulnerabilitiesgiven the macroeconomic environment.

The primary focus of this paper is on economiesthat have a local currency but where a high propor-tion of domestic financial transactions involving res-idents is denominated in dollars. Based on theanalysis, such highly dollarized economies pose themost serious risks and constraints. This paper refersto marginally or fully dollarized economies only to

the extent that they provide a benchmark and doesnot directly address stability issues associated withlarge, dollarized, offshore financial centers, wheretransactions with residents account for only a smallfraction of banks' balance sheets and where pruden-tial concerns are of a different nature. In addition,this paper mostly focuses on the domestic c o m p o -nent of financial dollarization (e.g., transactionsbetween residents) and refers to external dollariza-tion (e.g., transactions between residents and nonres-idents) only w h e n it has a direct bearing on thestability of the domestic financial system.

While examples are drawn more heavily fromthe Latin American region, the issues addressedare equally relevant to dollarized countries in other

Box 2. Dollarization Levels Versus Dollarization Risks

While high financial dollarization characterizesLatin American countries as well as transition econo-mies and some (non-Latin American) low-incomecountries, the levels and nature of financial intermedi-ation differ substantially a m o n g these three groups.Dollar intermediation in Latin American countries, asmeasured by the ratio of foreign currency depositsto G D P , is substantially higher than in transitioneconomies and (non-Latin American) low-incomecountries (see Table 2). The more limited scope forfinancial intermediation in transition economies and(non-Latin American) low-income countries isreflected in higher ratios of foreign assets held bybanks to foreign currency deposits (e.g., local foreigncurrency funding is primarily held abroad rather thanloaned out locally) and higher ratios of cross-borderdeposits to foreign currency deposits (e.g., the publicholds a large proportion of its foreign currency assets

abroad rather than in the local banking system). Whiledata limitations restrict the scope for similar cross-country comparisons of dollar cash holdings, there areindications that these are particularly important inm a n y of the transition economies (see Havrylyshyn andBeddies, 2002).

These differences, which are likely to have importantdifferential implications for financial stability, coulderode over time as dollar financial intermediation deep-ens in the transition economies and the (non-LatinAmerican) low-income countries. Liquidity risk islikely to be less of an issue in countries where local dol-lar deposits are small in magnitude and are not held assubstitutes for funds abroad or under the mattress. Inaddition, both liquidity risk and solvency risk areclearly more limited w h e n a large fraction of foreigncurrency deposits is held by local banks in the form ofliquid assets abroad rather than loaned out locally.

2

N u m b e r ofRegions Countries 1996 1997 1998 1999 2000 2001

South America 8 45.8 46.1 49.4 53.2 54 55.9Transition economies 26 37.3 38.9 43.5 44.3 46.9 47.7Middle East 7 36.5 37.2 37.7 37.5 38.2 41.9Africa 14 27.9 27.3 27.8 28.9 32.7 33.2Asia 13 24.9 28 26.8 28.8 28.7 28.2Central America and

Mexico 7 20.6 20.8 22 22.1 22.5 24.7Caribbean 10 6.3 7.6 6.8 6.7 6.1 6.2Industrial countries 14 7.4 7.5 7.5 6.7 7 6.6

Sources: National authorities; IMF, International Financial Statistics database; and IMF staff estimates.

I INTRODUCTION


Table 2. Indicators of Domestic Financial Intermediation in Foreign Currency, 2001(In percent)

Regions

ForeignCurrency

Deposits toGDP

Foreign Assetsto ForeignCurrencyDeposits

Cross-BorderDeposits to

ForeignCurrencyDeposits

Latin America1

Transition economies2

L o w income3

21.18.87.8

53.7104.1260.7

124.0130.9472.1

Sources: National authorities; Bank for International Settlements (BIS), International Financial Statistics; IMF, International Financial Statistics database; andIMF staff estimates.

1Includes 15 South and Central American countries.2Includes 23 transition economies.3Includes 13 African and 12 Asian countries.

regions of the world. The greater number of examplesin Latin America reflects that banking crises or near-crises have been more frequent or more directlyrelated to dollarization in this region. While the rea-sons underlying the relatively lower frequency offinancial crises, or the lesser role played by dollariza-tion in aggravating the crises, in other parts of theworld with equally dollarized financial systems arecomplex, the lower level of financial intermediationand less open capital accounts are probably importantexplanatory factors (Box 2 and Table 2). If so, highlydollarized non—Latin American countries couldbecome more vulnerable to such crises as their finan-

cial systems deepen and they become more integratedwith the international financial system. Hence, theexperiences of the highly dollarized Latin Americancountries provide useful lessons for other regions.

The remainder of this paper is organized as fol-lows: Section II examines the specific risks forfinancial soundness associated with dollarization;Section III discusses approaches to stopping bankruns and stabilizing liquidity conditions in the wakeof a banking crisis in a dollarized economy; SectionIV proposes measures to limit the risk of bankingcrises in dollarization-prone economies; and SectionV concludes.

3

Introduction


II Implications of Dollarization forFinancial Stability

Empirical evidence suggests that financial dollar-ization may increase the vulnerability of finan-

cial systems to solvency and liquidity risks. Simplecross-country estimates of the impact of dollariza-tion on some key financial soundness indicators,while controlling for changes in underlying macro-volatility, are consistent with the hypothesis thatincreased dollarization may increase financial vul-nerability. In particular, the variance of depositgrowth is positively and significantly correlated withdollarization, suggesting that dollarized financialsystems may be more exposed to credit cycles andliquidity risk (Table 3). Based on estimates of non-performing loans (NPLs) or a composite systemicrisk measure, the Z-index, which measures the prob-ability of insolvency of a firm, dollarized economiesalso may be more exposed to solvency risk (Box 3and Table 4).

Are Dollarized Financial SystemsInherently Vulnerable?

In comparing the financial vulnerability of dollar-ized and nondollarized systems, it is important toaccount for the fact that dollarization itself largelyarises as protection against risk. Financial dollariza-tion is, in large part, a response to currency instabili-

ty. Domestic borrowers and lenders prefer todenominate contracts in foreign currency when thatcurrency is expected to provide a more stable, andthus less risky, medium for intermediation.1 Hence,for a given underlying macrovolatility and monetaryregime, local currency lending could well be equallyrisky, if not more so, than dollar lending, because ofmore volatile, and often higher, real lending rates.Instead, to the extent that borrowers can hedgeagainst risk by borrowing in a mix of the two cur-rencies, a case can be made that bicurrency—forexample, partially dollarized—financial systemsshould be less risky than single currency systems.Explaining the apparent higher financial vulnerabili-ty of dollarized economies thus requires identifyingsystemic risks that are unique to dollarized systemsor that are linked to abrupt regime changes. Whenthese risks are not adequately internalized by finan-cial market participants, excessive dollarization andexposure to dollarization risks may ensue.

When choosing the currency in which to denominate financialcontracts, agents compare the expected volatility of the realexchange rate with that of inflation (see Ize and Levy Yeyati,2003). The persistence of financial dollarization after inflation hasstabilized may reflect continuing fears of a regime collapse and areturn to high and unstable inflation.

Sources: National authorities; IMF, International Financial Statistics database; and IMF staff estimates.

Note: DEPGV is the standard deviation of total deposit growth, AFCD is the 1995-2001 average ratio of foreign deposits to total deposits, INFV is

the variance of inflation, RERDV is the variance of real exchange rate depreciation, and COV is the covariance between inflation and real exchange rate

depreciation. DEPGV is computed with annual data for the 1990-2001 period. All other variables are computed with quarterly data for the 1995-2001

period. White heteroskedastic-consistent standard errors are shown in parentheses. ** denotes results at the 99 percent significance level.

Table 3. Deposit Volatility and Dollarization

Dependent Adjusted Number ofVariable AFCD INFV RERDV C O V R2 Countries

DEPGV 1.56** 0.30** 0.01 3.76** 0.94 58(0.52) (0.01) (0.01) (0.13)

4


What Are the Specific Financial Risks of Partial Dollarization?

Box 3. Systemic Risk Potential and Dollarization

Aggregate measures of bank risk taking for the entirebanking system can be viewed as proxies of systemicrisk potential. We consider two such proxy measures:the Z-index (Z) and the ratio of the nonperformingloans to total loans (NPL). The Z-index is a proxy of theprobability of insolvency of a firm. It combines in a sin-gle indicator: profitability, given by a period averagereturn on assets (ROA); leverage, given by the periodaverage equity capital-to-asset ratio (K); and returnvolatility, given by the period standard deviation ofreturns on asset (S). It is measured by the ratio(ROA + K)/S. Thus, Z increases with profitability(higher ROA), and decreases with leverage (lower K)and return volatility (higher S). A larger value of Z indi-cates a smaller risk profile, which can be attained byimproving efficiency (increasing ROA), greater diversi-fication (decreasing S), or larger capital (increasing K),or through a combination of these. When measured foran aggregate of firms, it can be viewed as the probabili-ty of insolvency of a firm whose ROA, K, and S are

weighted according to the size of its components. Thus,it is a proxy of systemic risk potential when measuredfor the aggregate banking system. Z-measures con-structed on the basis of 1995-2000 data taken fromnational authorities and the Fitch-IBCA banking data-base, are taken from De Nicolo and others (2003).

Table 4 presents the results of two regressions. Thedependent variables are a Z measure (ZT) and the 2001NPLs, both for the entire banking system. The inde-pendent variable of interest is financial dollarization, asmeasured by the 2001 ratio of foreign deposits to totaldeposits (FCD). Cross-country differences in themacroeconomic environment are controlled for by theaverage and variance of inflation (INF and INFV,respectively), average and variance of real exchangerate depreciation (RERD and RERDV, respectively),and the covariance between inflation and real exchangerate depreciation (COV). Inflation and real exchangerate depreciation are computed with quarterly data forthe 1995-2001 period.

What Are the Specific Financial Risksof Partial Dollarization?

Liquidity Risk

The dollar deposits held by non—U.S. banks areonly partially covered by liquid U.S. dollar assets.Since these deposits can potentially be withdrawn infull, dollarization subjects the financial system to avery specific type of liquidity risk. Systemic liquid-

ity risk in dollarized economies arises when thedemand for local assets falls, because of a perceivedincrease in country risk or banking risk, promptingdepositors to convert their deposits into cash dollarsor transfer them abroad, or foreign banks to recallshort-term lines of credit. Dollar liabilities need to bepaid at par against foreign currency, inhibiting equil-ibrating adjustments in the relative price of the twoassets (the exchange rate of local dollars against U.S.

Table 4. Impact of Dollarization on Financial Soundness Indicators

Sources: National authorities; Bureau van Dijk, Bankscope database; IMF, International Financial Statistics database; and IMF staff estimates.

Note: We find a negative and significant sign of FCD for the ZT regression, implying that systemic risk potential is positively correlated with financial

dollarization across countries. When the 2001 FCD ratio is replaced with the 1995 FCD ratio, the sign of FCD in the first regression remains negative

and significant, consistent with causality from dollarization to systemic risk potential. Furthermore, NPL appears larger in more highly dollarized coun-

tries because the sign of the coefficient associated with FCD is positive and significant. In sum, the evidence is suggestive of a positive relationship between

financial dollarization and systemic risk potential. All of these results are confirmed by the augmented versions of these regressions reported in De

Nicolo, Honohan, and Ize (2003). White heteroskedastic-consistent standard errors are in parentheses. ** denotes results at the 99 percent significance

level.

5

NumberDependent Adjusted ofVariable FCD INF RER INFV RERV COV R2 Countries

Z T - 0 . 0 6 * * 0.55 0.80 -0 .013 - 0 . 0 2 8 * * -0 .073 0.27 35(0.01) (0.54) (0.51) (0.117) (0.007) (0.15)

NPL 0.065** 1.16 - 0 . 0 7 -0 .124 0.039 -0 .149 0.08 42(0.003) (1.21) (1.09) (0.22) (0.033) (0.29)


IMPLICATIONS OF DOLLARIZATION FOR FINANCIAL STABILITY

dollars is fixed).2 Thus, unless liquid dollar liabilitiesare backed by sufficient liquid dollar assets abroad,banks may run out of dollar liquid reserves and failto pay off dollar deposits or other dollar liabilities ondemand, or as they fall due. Similarly, central banksmay run out of international reserves to provide dol-lar lender-of-last-resort support to distressed banks.3

When this happens, deposit (or loan) contracts mayneed to be broken and disruptive or confiscatorymeasures taken, thereby validating creditors' fearsand justifying the run (see Section III). The recentArgentine experience provides a fresh and vividillustration of a liquidity-induced banking crisis butthere have been many other similar crises or near-crisis episodes in dollarized countries in recent his-tory, including Mexico and Bolivia in 1982; Turkeyin 1994; Bolivia and Argentina in 1995; Bulgaria in1996; Peru and Russia in 1998; and Uruguay,Bolivia, and Paraguay in 2002 (Table 5).

The triggers for runs on dollar liabilities can be ofa diverse nature. Often, the runs were triggered byrapidly deteriorating macroeconomic conditions. Forexample, the Mexican 1982 crisis was triggered byan apparent loss of macroeconomic control, with arapidly expanding fiscal deficit and public debt, andweak and confusing monetary and exchange ratemanagement. The large claims of commercial bankson the government introduced a direct channel oftransmission from fiscal insolvency to bank insol-vency. A very similar sequence of events took placein Argentina during the more recent crisis. In othercases, as in Bolivia, the outflows were triggered byunfounded rumors of deposit confiscations or politi-cal turmoil. In still other cases, as in the recentUruguayan, Paraguayan, and, to some extent, Boliv-ian crises, contagion was a major determinant, asillustrated by the correlation of deposit outflows(Figure 1). Contagion was in part motivated by therisk of a freeze or a forced conversion of dollardeposits into local currency spreading to other coun-

Figure I. Foreign Currency Deposits(December 2000 = 100)

2Instead, a run against local currency bank instruments, to theextent that it is associated with a flight to foreign currency ratherthan local currency cash, can be stopped through an exchange rateovershoot (an asset market price adjustment) that immediatelyincreases their expected yield against dollar assets.

3The scope for "fiscalizing" dollar liquidity support, that is, forgiving banks in distress domestic dollar public securities insteadof foreign assets, is generally constrained by the limited marketacceptance and liquidity of such instruments in times of crisis.While Argentina attempted to follow this route, through a schemethat allowed local banks to obtain liquidity abroad against public(Bonex) bonds, the scheme fizzled during the recent crisis as con-ditions in Argentina worsened. The size of the liquidity fund wasprogressively reduced by foreign banks, and access to whatremained of the fund was limited as the secondary market price ofBonex bonds collapsed.

Sources: IMF, International Financial Statistics database; and IMFstaff estimates.

tries.4 Interestingly, however, not all countries wereaffected equally. Bolivia's deposit outflows seemedto have responded primarily to the uncertainty result-ing from the presidential elections. In Peru, whilethere was a reduction of foreign credit lines, depositswere not affected at all. In any event, it should benoted that liquidity crises in dollarized economies,like all banking crises, are, by their nature, hard topredict.

Dollar deposits are often more vulnerable to runsthan local currency deposits, even in the absence ofexchange rate adjustments. Except for Argentina,where a shift from local currency deposits to dollardeposits took place in the early stages of the run,reflecting fear of a currency depreciation, this wasthe case for the recent runs in the other SouthernCone countries (Figure 2).5 In highly dollarizedcountries, the relative stability of local currencydeposits also reflects the fact that they are mostly

4In Uruguay, the run started with Argentine depositors and laterspread to Uruguayans as unfolding events in Argentina wererelentlessly shown on local television stations. In Paraguay,deposit withdrawals were exacerbated by the closure of a majorlocal bank that failed in the wake of the difficulties experiencedby its Uruguayan-Argentine parent company.

5In Argentina, the run extended to dollar deposits as expectationsof a freeze or forced dedollarization became prevalent. (Note, how-ever, that the abrupt decline in dollar deposits that took place inearly 2002 reflects the compulsory change of these deposits intopesos—pesification—rather than deposit withdrawals.)

6

II


Wh

at A

re th

e S

pecific F

inan

cial Risks o

f Partia

l Do

llarization

?

Table 5. Bank Runs in Partially Dollarized Economies

CountryCase

Turkey(1994)

Argentina(1995)

Bulgaria(1996)

Russia(1998)

Ecuador(1999)

Argentina(2001)

Uruguay(2002)

Dollarizationof Deposit

46 percent

50 percent

40 percent

18 percent

76 percent

70 percent

85 percent

Trigger forthe Run

Sovereign downgradeand foreign exchangedepreciation.

Mexican crisis.

Deposit rationing bytwo banks.

Unsustainable fiscalexpansion leading togovernment debtmarket collapse.

Failures of majordomestic banks.

Exchange rate andgovernment debtconcerns.

Argentine crisis.

Extent ofthe Run

17 percent(January-March 1994)

18 percent(January-March 1995)

7 percent(January-August 1998)

29 percent(January 1998-March 1999)

22 percentduring 2001

10 percentduring 2002

Treatment ofDollar Deposits

Full guarantee of all householddeposits, and liquidity of up to200 percent of capital availableto banks.

Heavy, but ad hoc, liquidityassistance provided in dollars.

Closure of some banks, choiceof full guarantee of foreignexchange deposits in domesticcurrency or gradual payout indollars over two years.

Household deposits at sixmajor banks transferred to astate bank, but repaid in rublesat a fixed exchange rate.Liquidity provided only inrubles to the state bank andto other banks.

The first attempt at resolutionwas a bank holiday followed bya deposit freeze andtemporary securitization.When the run reemerged asthe freeze was lifted, formaldollarization took place.

Partial deposit freeze, followedby forced dedollarization andmaturity extension.Voluntarysecuritization of 12 percent ofdeposits.

Domestic banks: dollarliquidity to sight deposits,maturity extension of timedeposits. Foreign banks:headquarters liquidity in caseof need.

Treatment of LocalCurrency Deposits

Same as for dollardeposits.

Liquidity assistancein domesticcurrency.

Full guarantee andliquidity in localcurrency.



Similar partialdeposit freeze andheavy liquidityassistance afterdedollarization.

Domestic banks:liquidity to alldeposits.Foreign banks:headquartersliquidity in case ofneed.

Outcome

Outflows from sound banks were halted by guarantee,allowing insolvent banks to be closed, but lack ofsupervisory follow-up left banking system vulnerable.

Outflows diminished in due course, with 10 smallerbanks closed and ad hoc liquidity provided to others.There was deposit flight to quality.

Outflows halted once a second wave of withdrawalseliminated all bankrupt banks from the system and fullguarantee and earmarked funds were in place forremaining banks. Banking system remained healthywithout liquidity needs once currency board was inplace.

The transfer of deposits to the state banks was aneffective guarantee of almost all household deposits, butdata do not show whether it stopped the run.Thestandstill, although unpopular, did not prevent capitalreflows when the economy improved.

The deposit freeze halted the outflows initially, but socialpressures caused the freeze to be gradually relaxedahead of schedule. Further runs occurred as the easingtook place, leading to renewed currency crisis andgovernment default. Formal dollarization eventually wassuccessful in easing deposit outflows.

Social unrest and sharpened recession. Leakagesoccurred under the deposit freeze, partly from legalchallenges.

Outflows halted once 100 percent of unrestricteddeposits were covered by earmarked funds, butgovernment debt sustainability is now in question.

Sources: National authorities; and IMF staff estimates.

7



Figure 2. Foreign and Local Currency Deposits(In millions of U.S. dollars)

Sources: IMF, International Fincial Statistics database; and IMF staff estimates.Note: Local currency deposits are converted at a constant exchange rate at the beginning of the period.

held for transaction purposes. Thus, they are lessaffected by expected yield differentials than dollardeposits, which are predominantly held as stores ofvalue and are close substitutes for deposits abroad orcash dollars.6 Moreover, even when the demand forlocal currency deposits is affected, the small size ofthese deposits in the most highly dollarized countrieslimits the threat they represent for banks' liquidity.

6Moreover, dollar deposits are, on average, substantially largerthan local currency deposits and fewer in number. As a result, theyare more vulnerable to rumors and portfolio reallocations by afew large depositors. In Bolivia, for example, nearly half of alldollar deposits are above US$100,000 and are held by fewer than1 percent of total depositors.

The lack of dollar monetary instruments can fur-ther inhibit the scope for interest rate defensesagainst deposit withdrawals. As in the case of fixedpegs, an interest rate defense that validates changesin risk premiums may be ineffective once a run hasstarted. What is peculiar to dollarized systems, how-ever, is that in the absence of a monetary policy indollars, the lack of monetary signals from the centralbank requires that banks take the initiative to raisetheir dollar deposit rate. Banks are often reluctant todo so, reflecting concerns that increases by individ-ual banks may be interpreted as a sign of weakness,further exacerbating deposits withdrawals. Indeed,there was nearly no dollar deposit rate responseto the recent deposit withdrawals in Uruguay and

II

8



Figure 3. Interest Rates on ForeignCurrency Deposits(In percent)

Source: IMF, International Financial Statistics database.

Paraguay, where central banks do not have dollar-denominated monetary instruments (Figure 3).Instead, in Argentina and Bolivia, where dollar-denominated monetary instruments exist, the interestrate response was more significant.

Solvency Risk

The main solvency risk faced by dollarized finan-cial systems results from currency mismatches in theevent of large depreciations. In turn, currency mis-matches can affect banks' balance sheets directly oraffect them indirectly by undermining the quality oftheir dollar loan portfolio. Banks' direct exposure tocurrency risk is generally limited by tight regulatorylimits on open foreign exchange positions. However,controlling banks' positions in derivatives, which areoften misreported, have been a frequent source ofdifficulties.7

Currency-induced credit risk is a key, mostly un-regulated, source of vulnerability. The main sourceof currency risk for banks in highly dollarizedeconomies generally is the exposed position of theirborrowers, which makes them susceptible to defaultin the event of a large depreciation. The availability oflocal currency loans is not sufficient to meet theneeds of clients in the nontradable sector whose cashflow is in local currency. At the same time, bankswith large domestic dollar liabilities must balance

their foreign exchange positions by either extendingdollar lending to local currency earners or holdingdollar assets abroad. To maintain their profitability—in view of the generally much lower rates of return onforeign assets than on local dollar assets—and satisfythe pent-up demand for loans, banks generally end upon-lending domestically a large share of their dollardeposits, effectively transferring the currency risk totheir unhedged clients and retaining the resultingcredit risk.8 The share of total dollar loans granted toborrowers in the nontradable sector thus reached, inmid-2002, more than 65 percent in Bolivia, about 50percent in Costa Rica, 60 percent in Peru, and 80 per-cent in Paraguay. The scope for borrowers' currencymismatch is enhanced by the fact that prices andwages may continue to be set in local currency (e.g.,real dollarization remains limited) even when finan-cial dollarization is widespread.9 Counterparty expo-sure is also amplified if the value of the collateralbacking the loan obligation is denominated in domes-tic currency and declines relative to the loan, conse-quent on the exchange rate movement.

In the event of large depreciations, widespreadcurrency mismatches can have macrosystemic rippleeffects that compound the deterioration of banks'financial situation. As a result of balance sheeteffects, large devaluations in highly dollarizedeconomies are more likely to be contractionary,thereby further undermining borrowers' capacity toservice their debts. By undermining the solvency ofboth borrowers and banks, the credit risk derivingfrom a large devaluation also increases the scope fora credit crunch and heightens the risk of depositwithdrawals by concerned depositors, whether inanticipation or as a reaction to the devaluation. Thus,solvency and liquidity risks are closely interrelated.

7See Lane and others (1999) for examples drawn from theAsian banking crises and Garber (1996) for the case of Mexico.

8As shown in Figure 4, however, the cross-country relationshipbetween loan dollarization and deposit dollarization is generallyless than proportional. A 10 percent increase in foreign currencydeposits results, on average, in a 7.3 percent increase in foreigncurrency loans. This asymmetry was first detected by Honohanand Shi (2002).

9Real dollarization, as measured by the pass-through ofexchange rates on prices, is correlated with financial dollarizationbut is generally much lower. A regression analysis, based on dataprovided by Choudhri and Hakura (2001), suggests that the elas-ticity between financial dollarization and real dollarization is onlyabout 0.25 (see Figure 5; similar evidence is reported by Honohanand Shi, 2002). This broad-brush empirical evidence is supportedby casual evidence in highly dollarized countries, such as Boliviaand Peru, which indicates that the vast majority of wages contin-ues to be paid in local currency, with only few exceptions (such asfor some top executives). Nonetheless, dollar indexation appearsto have made inroads over the years. In Bolivia, for example, itnow affects most utility prices, pensions, some elements of the taxsystem, accounting standards, and some supplier contracts. InPeru, a number of services, including residential and commercialleases, real estate, professional services, and insurance premiums,are priced in dollars.

9



Figure 4. Deposit and Loan Dollarization(Logarithms of ratios in percent)

Sources: National authorities; IMF, International FinancialStatistics database; and IMF staff estimates.

Figure 6. Dollarization and Volatility ofthe Bilateral Real Exchange Rate tothe U.S. Dollar, 1990-2001


The interaction between prudential risks and themonetary regime, which instills a "fear of floating,"subjects the financial system to risks similar to thoseincurred under a rigid exchange rate system. The morefinancially dollarized an economy, the more vulnerableit is to large exchange rate fluctuations, and, hence, theless disposed the monetary authorities are to let theexchange rate float. Concerns about the potential infla-tionary impact of large exchange rate adjustments canexacerbate the monetary authorities' "survival" instinctto cling to the exchange rate as a lifeline. In turn, the

Figure 5. Real and Financial Dollarization(In percent)

less exchange rate volatility there is, the more dollar-ized an economy becomes. Dollarization can thusbecome a "trap" in which monetary policy ends uphostage to the need to protect the soundness of thefinancial system and keep inflationary expectations "inthe bottle." Indeed, there is good empirical evidencethat both nominal and real bilateral exchange rates areless volatile in more dollarized economies.10 Instead,interest rates must bear the brunt of the adjustment toshocks, raising interest rate risk for both local currencyand dollar intermediation. Heightened credit cycles,often a prelude to banking crises, constitute anotherkey source of risk. Credit booms are accentuated by thefact that incoming dollar flows—capital flight repatria-tion, portfolio investment by foreigners, or foreign bor-rowing by banks—feed domestic lending and, throughthe banking multiplier, boost dollar intermediation. Thetendency of real exchange rates to appreciate accentu-ates the cycle by reducing the burden of dollar debt andenhancing the value of collateral in the nontradablesector, thereby relaxing credit constraints.11 The scopefor intervention by the monetary authorities isextremely limited.12

10Figure 6 offers suggestive evidence. Levy Yeyati, Sturzeneg-ger, and Reggio (2002) provide a formal empirical analysis.

11See Tornell and Westermann (2002).12While some countries, for example, Bolivia, have well-

developed dollar monetary instruments, their use for counter-cyclical policy is severely constrained. During periods of boom,the cost of sterilizing capital inflows in the presence of substantialcountry premiums becomes, in practice, rapidly insurmountable.During downturns, relaxing monetary policy mostly induces cap-ital outflows and losses of international reserves.

II


10



Once an exchange rate collapse occurs, the impacton banks' solvency can be devastating. As long as theprevailing monetary regime remains unaltered, bor-rowers should choose the currency composition oftheir debt in a way that minimizes their exposure torisk. Thus, the risk from dollar lending mainly origi-nates from a sudden, large change in the monetaryand exchange rate regime, typically a large deprecia-tion taking place after years of controlled and stableexchange rates. The stronger and more pronouncedthe monetary authorities' commitment to a peg, as inthe case of a currency board, the more damaging it isto break this commitment. At this juncture, timeinconsistency and moral hazard arguments clearlytake center stage. The maintenance of a stableexchange rate is perceived as an implicit commitmentof the monetary authorities, and reneging on thiscommitment is a "catastrophic" event that warrantsgovernment intervention to limit the resulting eco-nomic disruption.13 Thus, expectations of a wide-spread bailout in the event of an abrupt exchangerate depreciation pervade the portfolio choices ofdepositors, borrowers, and banks, encouraging alevel of financial dollarization above what would besocially desirable.14

13The provision of (implicit) public insurance is justified by thegovernment's inability to precommit itself against bailouts, or itsunwillingness to do so, due to the immediate stimulating impacton credit and economic activity of "guaranteed" access to cheapdollar financing. See Burnside, Eichenbaum, and Rebelo (2001).

14See, among others, Mishkin (1997); Obstfeld (1998); Dooley(2000); and Burnside, Eichenbaum, and Rebelo (2001). Moralhazard is not the only factor underlying socially excessive levelsof dollarization. Other factors discussed in the literature includemarket failures associated with debt defaults and inferior marketequilibria derived from policy endogeneity. See Aghion, Bacchet-ta, and Banerjee (2001); Chamon and Hausmann (2002); and

Against this background, pegs or quasi-pegs thatare not perceived to be fully sustainable can en-courage dollarization by enhancing the value of thegovernment guarantee. In particular, in stronglyanchored regimes, economic agents must, by design,be assured that the fix will hold indefinitely. Thismay preclude the development of prudential regula-tions to properly manage exchange-rate-inducedcredit risks and maximizes incentives to borrow inforeign currency. Even if banks and borrowersremain aware that the current regime could collapse,they expect, and feel they deserve, to be bailed out ifit does.

The dollarization of public debt can be an impor-tant collateral source of financial fragility whenbanks have large holdings of public securities.15

Sharp exchange rate depreciations can underminethe sustainability of the public debt, in turn under-mining the solvency of banks when they hold largevolumes of public securities. This can affect finan-cial systems that, because of administrative restric-tions, are not themselves dollarized.

Broda and Levy Yeyati (2003). While economic agents' limitedforesight could also be invoked to justify borrowers' preferencefor apparently cheaper dollar loans, the asymmetric behavior ofdepositors (who prefer to hold apparently lower-yielding dollardeposits) suggests that other factors are at play.

15The dollarization of domestic public debt largely reflects fac-tors similar to those driving financial intermediation. Public admin-istrations view the probability of a large devaluation as remoteunder their current tenure, discount the cost to subsequent adminis-trations of dealing with a currency and debt crisis, or choose to bor-row in foreign currency to signal their commitment to a stableexchange rate. Incentives to borrow in dollars are exacerbated inheavily dollarized economies by the high cost of issuing large vol-umes of domestic currency debt (e.g., of not accommodating thepublic's preference for dollar-denominated debt).

11


Managing Bank Runs inDollarized Countries

Dealing with bank runs in dollarized economiesis both more difficult and subject to greater

risks than in other cases.16 The absence of a lender oflast resort has a potential to make dollarized systemsmore prone to runs, and runs more difficult to stopwhen they occur. A strategy to address runs cannotrely to the same extent on the provision of liquidityand on deposit guarantees, the two key elementsidentified for other cases. The additional constraintscall for more attention to financial sector soundness.In the cases where, in spite of such added vigilance,bank runs do occur, theory and country experiencessuggest that the authorities may need to resort earlierand more frequently to administrative measures thatrestrict the availability of deposits, or else seek inter-national support on a larger scale (Table 5).

Provision of Emergency Liquidity

The limited availability of dollar liquidity calls fora carefully designed strategy on liquidity provision.Dollar assistance can be provided as long as suffi-cient dollar resources are available. Sources of li-quidity can include high international reserves priorto the run (e.g., Argentina in 1995); contingent facil-ities such as swaps and repos; or international finan-cial support (e.g., Mexico in 1995). Drawing downsuch resources can, however, have costs in terms ofcredibility and limitations on macroeconomic poli-cymaking. Limited availability of dollars raises thequestion of whether to shift assistance in part or infull to local currency (e.g., Bulgaria in 1996, Russiain 1998, and Ecuador in 1999). This option avoidsthe need for other administrative measures and cir-cumvents constraints on liquidity assistance becausethe central bank can print local currency. However,

16While this section deals primarily with liquidity issues, sol-vency issues in the aftermath of a banking crisis and a large depre-ciation in a highly dollarized country may also constitute majorobstacles in view of the widespread losses to which banks arelikely to be exposed. However, differences in relation to manag-ing banking crises in nondollarized countries are more quantita-tive than qualitative. Thus, no fundamental modifications inpolicy response seem to be necessary. A broader discussion ofsuch issues is contained in Hoelscher and Quintyn (2003).

the expansion in the money supply and the currencymismatch are likely to result in a combination of lossof international reserves, exchange rate depreciation,and inflation. Moreover, currency denomination ofthe liquidity is inconsistent with depositors' prefer-ences. Providing local currency liquidity is thereforelikely to be less effective in restoring depositor con-fidence than liquidity provision in dollars would be.

Depositor Protection

The lack of dollar-backing sharply limits the scopefor a dollar-based blanket guarantee. Depositor pro-tection, in particular through a blanket guarantee, hasoften been important in addressing systemic bankruns.17 In a dollarized economy, funding constraintsemerge, similar to those discussed above in the caseof liquidity support. A guarantee of deposits in for-eign currency can be effective as long as sufficientdollar backing is available. In some countries, mostnotably the transition economies, banking systemswere small enough that a full government-backedblanket guarantee of foreign currency deposits mayhave been an option. In most others though, reserveand fiscal constraints render a blanket guaranteeissued in foreign currency not credible.18

Few alternatives to blanket guarantees are avail-able. A blanket guarantee in local currency isunlikely to instill depositor confidence, becausedepositors will demand their original dollars ratherthan the local currency counterpart. Moreover, theannouncement of a local currency guarantee mayaggravate the crisis if depositors fear that the bank-ing system does not have sufficient dollar resourcesand, therefore, seek to buy dollars in the exchangemarket. Guaranteeing deposits in local currency at afixed exchange rate (Russia in 1998) implies a lossto depositors when the exchange rate depreciates and

17Notwithstanding the crucial role played by blanket guaranteesin stopping bank runs, a full assessment of their costs and bene-fits needs to be mindful of their moral hazard implications.

18Where a funded deposit insurance system is in place, partialcoverage in foreign currency may be available from accumulatedfunds. However, deposit insurance funds will not generally pro-vide sufficient backing for blanket guarantees.

Ill

12


Administrative Measures

depositors are therefore likely to withdraw theirfunds and convert them to foreign exchange as soonas possible. Another option would be to transferdeposits in failed banks to a public or private bankthat is perceived to be sound and with significantforeign exchange holdings, backed up by corre-sponding holdings of central bank securities toensure liquidity. Under the conditions of a systemicrun, such banks only exist in rare cases.

Administrative Measures

Given the added constraints of dollarization forliquidity support and depositor protection, adminis-trative measures—such as securitization of deposits,the extension of deposit maturities, or the impositionof bank holidays or other restrictions on depositwithdrawals—are more likely to be needed thanwhen a crisis occurs in a local currency environment.These measures should be adopted under the generalprinciples of transparency, least fiscal cost, and uni-formity of treatment. However, where banks' capaci-ty to withstand liquidity shocks is clearly uneven,with some banks benefiting, for example, fromopen-ended support from their foreign parents, somecountries have imposed administrative measuresselectively, as in the recent Uruguayan banking cri-sis. The risks of asymmetric treatment of banks needto be balanced against the benefits of shielding atleast part of the banking system from the adverseimpact of altering financial contracts unilaterally.

Securitizing deposits is preferable to a freeze or anoutright default. A securitization of deposits (e.g.,Argentina in 2002, Ecuador in 1999) may be lessdamaging to depositors than a deposit freeze or anoutright default because a secondary market in suchinstruments can enhance their liquidity, albeit at aloss if the bonds trade at a discount and are sold forcash before maturity. There are a variety of modali-ties for swapping bank deposits into bonds, andpossible trade-offs need to be considered whendesigning the strategy. In particular, depositors couldreceive a government bond or a bond drawn on thecommercial bank. Commercial bank securities maybe the appropriate instrument if the bank is consid-ered viable in the medium term.19 To the extent the

19Under a crisis situation, however, banks' financial conditionsare often unknown. In the context of a forced securitization, there-fore, bank securities might be offered as a voluntary option togovernment bonds, possibly along with a voluntary option to con-vert them into bank equity.

bank holds government paper, it could also swapdeposits for government bonds out of its portfolio,thereby avoiding net debt creation. If neither condi-tion is fulfilled, the government can assist by issuingnew bonds; the usefulness of this option depends onmedium-term fiscal sustainability.

Securitization should be accompanied by steps tomitigate its impact on financial intermediation, thepayments system, and economic activity. Specificsteps could include (1) making securities transfer-able and stimulating a secondary market in bonds;(2) issuing securities in sufficiently small denomina-tions; or (3) making securities for certain transac-tions, such as purchase of government assets,transferable. While these steps would strengthendemand for such instruments and strengthen the sec-ondary market, the extent to which they can be usedis limited by the government's cash needs. To avoidcircumvention and loss of credibility, there should befew exceptions from the general policy concerningsecuritization of deposits.

Extending deposit maturities may be the onlychoice left if deposits cannot be securitized. Thisoption—a form of securitization with nontradablebank instruments—was implemented, for instance,in both Argentina and Uruguay in 2002. Whiledeposits with extended maturities are frozen in thebanking system and not converted into negotiableinstruments, measures should be considered toimprove the functioning of the payments systemunder such a freeze. Frozen accounts should havefull mobility within the banking system, and limitedweekly or monthly withdrawals should be allowed.The authorities should be prepared for the fact thatmobility within the system may lead to flight-to-quality as depositors move frozen deposits to thestrongest banks in the system.

Limitations on deposit withdrawals should beclearly defined, rather than being left open ended.Freezes without specified minimum weekly ormonthly withdrawal amounts, or outright bank holi-days, are an unstable solution to deposit runs andshould be avoided. If established, they should only bein place for limited time periods to buy the authori-ties time to work out a permanent solution.

Nominal losses to depositors should be consideredas a last resort. Such action should only be taken ifall the above options cannot be implemented or havefailed. Nominal losses will make reintermediation inthe financial system more difficult to achieve, evenin the medium run.

13


IV Prudential Framework for ManagingDollarization Risks

At present, only a few of the highly dollarizedcountries issue explicit regulations to limit

banks' exposure to currency-induced credit risk.Based on a survey of prudential practices in a sam-ple of countries with different degrees of dollariza-tion, there is only limited evidence of specificadaptations to manage credit and interest rate risks(Table 6). Interestingly enough, the less dollarizedcountries are the ones that have the more explicit reg-ulations addressing dollarization risks. With oneexception, no specific prudential measures to limitbanks' indirect exposure to currency risk werereported by the highly dollarized countries, perhapsbecause the high financial dollarization makes themdifficult to implement and excessively costly interms of financial disintermediation. By contrast,economies with low financial dollarization had vari-ous types of limitations in place, including an out-right prohibition to lend to borrowers in thenontradable sector (Chile); quantitative limitationson lending and a prohibition for households to holdforeign currency deposits (Mexico); and an outrightprohibition of foreign currency lending other thanon-lending of foreign credit in combination with anacross-the-board prohibition to hold foreign cur-rency deposits (Brazil).20

How Are Dollarized CountriesManaging Dollarization Risks?

Some adaptations have been made to regulationson open foreign exchange positions. To limit banks'direct exposure to foreign exchange risk, severalhighly dollarized countries have broadened the limitson open foreign exchange positions to facilitate deal-ing with temporary fluctuations in the currencycomposition of banks' balance sheets and allowedbanks to maintain long dollar positions (to protectbanks' capital-asset ratios from exchange rate fluctu-

ations).21 In addition, some countries have intro-duced capital requirements against banks' foreignexchange exposures. In contrast, consistent with thecurrency board's commitment to preserve theexchange rate, some currency board countries(Argentina, prior to the crisis, and Bulgaria) haveformally excluded from the calculation of banks'open positions, the positions in the currency towhich the exchange rate was pegged.22

While many highly dollarized countries have takensome prudential measures to limit liquidity risk, theextent and nature of the safeguards vary substantiallyacross countries. High liquidity or reserve require-ments on foreign currency deposits, held at least inpart in the form of liquid dollar assets abroad ordeposited at the central bank and backed, explicitly orimplicitly, by international reserves, are often used asa liquidity buffer, to be lowered in times of crisis.23

Indeed, gross international reserves, of which aboutone-third originates from required dollar reservesdeposited by banks at the central bank, covered nearlyall foreign currency deposits in the Peruvian bankingsystem during 2002. Together with sound fundamen-tals, this helps explain the stability of foreign ex-change deposits in Peru during the recent Argentinecrisis (see Figure 1 and Box 4). Reserve or liquidityrequirements are often higher on dollar deposits thanon local currency deposits, and often differentiatedaccording to the maturity of the deposits, reflecting

20Causality may also apply in the opposite direction, however,as tighter prudential norms on foreign exchange lending in thesecountries may have contributed to maintaining a lower level ofdollarization.

21When a bank with X percent of its liabilities denominated indollars is allowed to have a long structural dollar position equiva-lent to X percent of its capital, this is equivalent to separating thebank into a "dollar bank" (accounting for X percent of the total)and a "local currency bank" (accounting for 1 — X percent of thetotal), each with its proportional share of the bank's total capital.Under such an arrangement, the bank's capital-to-asset ratiobecomes fully immune to exchange rate fluctuations.

22Not all currency boards have followed this approach, how-ever. For example, Hong Kong maintains strict limits on all for-eign exchange exposures, including against the U.S. dollar, towhich the currency board is pegged.

23In Argentina, during the Tequila Crisis, reserve requirementswere lowered from 43 percent to 20 percent. In Peru in 1998, fol-lowing a significant recall of external credit lines to banks, thecentral bank reduced foreign currency marginal reserve require-ments from 45 percent to 20 percent.

14


How Are Dollarized Countries Managing Dollarization Risks?

Box 4. Costs and Benefits of Norms to Control Liquidity Risk:The Case of Peru

This box estimates the joint costs and benefits ofthree prudential regulations aimed at limiting liquidityrisk in the Peruvian banking system: (1) reserverequirements; (2) liquidity requirements; and (3) de-posit insurance.

Prudential NormsReserve requirements: Required reserves are held as

vault cash or deposits at the central bank, in the deposit'scurrency denomination. In addition to a basic 6 percentrate that applies to all deposits, foreign currency deposits(FCD) are also subject to a 20 percent marginal require-ment (down from 45 percent in 1998). Thus, averagerequired reserves on FCD are currently 32.5 percent.The central bank does not pay interest on reserves up to6 percent and pays the 3-month LIBOR rate minus 1/8on foreign currency reserves above 6 percent.

Liquidity requirements: Banks are required by thesupervisory authorities to hold liquid assets equivalentto at least 8 percent and 20 percent of all their liabilitiesmaturing during the next 12 months, in domestic cur-rency and foreign currency, respectively. Eligible assetsinclude vault cash, deposits at the central bank, centralbank certificates of deposit, deposits in first-rate for-eign banks, and investments in securities negotiated incentralized markets and rated as investment grade byinternational rating agencies.

Deposit insurance: Banks are required to make quar-terly contributions to a deposit insurance fund at a rateequivalent to 0.48 percent of insured deposits (U.S. dol-lars and Peruvian nuevos soles).

CostsBoth liquidity and reserve requirements affect banks'

profits, as liquid prime assets normally earn lower

returns than less liquid assets and reserve require-ments are remunerated at below market rates. Thedeposit insurance affects banks' profits by increasingtheir expenditures. Assuming that, in the absence ofliquidity or reserve requirements, banks would onlyhold liquid assets equivalent to 5.5 percent of localcurrency liabilities and 3.6 percent of foreign cur-rency liabilities, costs would amount to 2.2 percentof liabilities in foreign currency (1.9 percent forreserve requirements, 1.1 percent for liquidity require-ments, and 0.15 percent for the deposit insurance) and0.4 percent of liabilities in domestic currency (0.08percent for reserve requirements, 0.3 percent for li-quidity requirements, and 0.1 percent for the depositinsurance).

BenefitsThe marginal contribution of the liquidity and

reserve requirements to limiting liquidity risk can beestimated by subtracting the liquid assets that bankswould hold voluntarily from the required liquid assets,which amounts to about 18 percent of total bank lia-bilities. This is substantially above the maximumrun experienced by the Peruvian banking systemfrom 1993 to June 2002 (see Table 7). However, runsdo not affect all banks equally as they are usuallyaccompanied by a flight to quality. For instance,during the 1998 run, the maximum run experiencedby a single institution (including reductions of short-term foreign lines of credit) amounted to 35 percentof its liabilities. Thus, the level of protection providedby the regulations would not have been sufficientto withstand the largest run at the individual banklevel.

their differential exposure to liquidity risk. Toenhance the effectiveness of these regulations, somecountries, such as Bolivia and Uruguay, have com-plemented them with regulations to discourage earlywithdrawals.24 Other countries, such as Israel, haveintroduced minimum maturity requirements on for-eign currency deposits in the banking system.25

24In Bolivia, time deposits with longer than two years' maturityare exempt from the 12 percent reserve requirement and earlywithdrawals are prohibited. These deposits are actively negotiatedin the stock market, at discounts that can be significant when li-quidity market conditions are tight.

25In 1985, as part of a stabilization package, Israel introduced aminimum holding period of one year on new dollar-linkedPATAM deposits, reducing their attractiveness relative to otherindexed financial instruments (see Bufman and Leiderman,1995). PATAM deposits were subsequently phased out andreplaced by alternative, dollar instruments (PATZAM andPAMAH), which are subject to decreasing reserve requirementsas their maturity increases but are otherwise unrestricted.

While less effective in dealing with systemic runs,limits on maturity mismatches have also been intro-duced by a number of dollarized countries. Less-intrusive regulatory guidelines are generally alsoprovided to orient banks' liquidity risk manage-ment.26 In the case of branches of foreign banks,some countries, such as Paraguay, have imposed theprovision of support from their main offices as a pre-condition for licensing.

While adaptations sometimes have been made tosafety-net arrangements, the scope for dollar liquiditysupport varies substantially across countries. Coun-tries such as Armenia, Bolivia, and Peru have explicitarrangements to provide liquidity assistance in foreigncurrency. To enhance the credibility of lender-of-last-

26These normally require the definition of a liquidity manage-ment strategy, based on liquidity gaps and stress scenarios (whoseparameters may be provided by the supervisor).

15


PRUDENTIAL FRAMEWORK FOR MANAGING DOLLARIZATION RISKS

Table 6. Risk Management Arrangements in Dollarized Economies

CountryCase Credit Risk

Liquidity Risk

Liquidity/reserve buffersDifferential liquidity/

reserve requirements

Partially dollarized countriesArgentina No specific measures. Liquidity requirements were lowered from No.

43 percent to 20 percent during a16 percent deposit run in 1994.

Armenia No specific measures. No. No.

Bolivia No specific measures.

Bulgaria No specific measures.

10 percent liquidity requirement. Central No.bank uses foreign currency deposits ascollateral for lender of last resort.

No. No.

Cambodia No specific measures.

Peru No specific measures.

Turkey List of selected borrowers'types.

No.

Foreign currency reserve requirementslowered from 45 to 20 percent in 1998following a creditor run.

No.

No.

Minimum liquidity requirement: 8 percent indomestic currency and 20 percent in foreigncurrency.

Liquidity requirements: 6 percent in domesticcurrency and 11 percent in foreign currency.

Uruguay No specific measures. No. No.

Zambia No specific measures. No. No.

Fully dollarized countriesEcuador No specific measures.

Panama No specific measures.

No.

No.

No.

No.

Control group: Nondollarized countries No.Brazil Foreign currency contracts are null

and void, including lending, excepton-lending of external loans.

Chile Until recently, unhedged foreign No.currency borrowing was prohibited.

Mexico There are maximum lending limits Yes, in foreign exchange.on the amount that banks may lendto individual borrowers.

No.

Reserve requirements lower in domesticcurrency (3.6—9 percent vs. 13.6—19 percentin foreign currency).

Liquidity coefficient in foreign exchange.

Source: IMF staff estimates.

IV

16


How Are Dollarized Countries Managing Dollarization Risks?

Liquidity Risk

Limits on maturitymismatches Other

Lender of Last Resort inForeign Currency Foreign Exchange

17

Limits on gaps from Central bank can increase Instruments in foreign currency and Pre-2002, capital requirement forone week up to requirements if concentration of preapproved credit lines. foreign exchange risk based on thethree months. liabilities is detected. per-currency exposure and volatility,

except U.S. dollars.

No. Reserve requirements on foreign Central bank credit in foreign currency. Symmetric limit of 25 percent of bank'scurrency deposits to be deposited capital (5 percent in a less liquid singlein domestic currency. currency).

No. Zero percent reserve requirement Central bank foreign currency credit, Limit of 80 percent of bank capitalover 2 years (no early withdrawal). outright repurchase agreements, and minus fixed assets on net dollar assets

cross-currency repurchase agreements. and 20 percent on net liabilities.

No. Liquidity stress testing. No. Limit: 30 percent of capital, excepteuros. 100 percent risk weight for2 percent net foreign position.

No. One-month report on maturity No. Limit at 5 percent of the bank's netgaps. worth.

No. Protocol covering deposit and Central bank foreign currency credit, Net dollar assets higher than -2.5credit runs. swaps, and indexed deposit certificates. percent and lower than 100 percent of

Protocol to cover runs. capital.

Limit equivalent to 3 percent reserve requirement in No. Symmetric overall limit of 20 percentbank capital on net foreign currency. of bank's capital.assets over3 years.

No. Reserve requirements: 10 percent Central bank issues certificates of deposit Symmetric limit of 1.5 times equity.up to 30 days, 4 percent for in dollars.30-180 days, and 2 percent over180 days.

No. Reserve requirements on foreign No. Symmetric overall limit of 15 percentcurrency deposits to be partly of bank's capital. Capital requirementdeposited in domestic currency. for 100 percent of open position.

"Liquidity at risk" limit Maturity gaps required starting Repurchase agreements with central Value-at-risk minimum capital foron negative in December 2002. bank paper. foreign exchange risk by Decembercumulative gap vs. 2003.liquid assets.

No. 30 percent liquidity requirement, The National Bank of Panama can grant Minimum capital for foreign exchange20 percent if interbank deposits credit to other banking institutions. exposures set internally by banks.are significant.

No. Liquidity stress testing. No. Limit of 60 percent of equity. Value-at-risk capital requirement on foreignexchange exposures

Limits on 30-day and Short-term liabilities exceeding Central bank foreign currency credit, Limit on the overall position of 2090-day gaps. 2.5 times capital have to be held as promissory notes, and swaps. percent of basic capital, differentiated

cash or central bank reserves. by country risk.

Limit on 60-day Zero reserve requirements. No. Net assets or liabilities cannot exceedgaps. 15 percent of capital.



Table 7. Creditor Runs in the Peruvian Banking System1

Sources: Superintendency of Banks and Insurance Companies of Peru, Statistical Bulletin (various issues).1Includes recalls of short-term foreign lines of credit.2Only considers declines of over 2 percent of total bank liabilities. It is assumed that a run ends when liabilities grow or are stable for two consecutive months.

resort arrangements, whether in local currency orforeign currency, dollarized countries generally holdhigher international reserves (Figure 7). However, therelationship between international reserves, as a shareof M2, and financial dollarization is much less than

Figure 7. Average Dollarization andOfficial Reserves to M2, 1996-2001(In percent)


proportional—a 10 percent increase in dollarizationresults in only a 3 percent increase in internationalreserves—and there is very wide cross-country dis-persion.27 Central banks of several countries, such asBolivia, Argentina, Chile, Peru, and Uruguay, haveintroduced debt instruments denominated in dollars,or indexed to the dollar, as a way to enhance flexibili-ty in the use of international reserves, limit exchangerate volatility, and, in some cases, to facilitate thedomestic recycling of dollar liquidity. With regard todeposit insurance, the countries generally do not makedistinctions in the extent of coverage provided fordomestic or foreign currency deposits. However, theinsurance is normally paid out in domestic currency,at exchange rates that are set out in the regulation.

Is a Regulatory Tightening Needed?

The existing regulatory response to dollarizationrisk appears to be generally uneven and often insuf-ficient. As outlined above, the regulatory response toliquidity risk varies widely across countries. In many

27In addition to holding large international reserves, preap-proved contingency lines from foreign banks have been usedto augment possible liquidity support. For example, Argentina'spreapproved credit line from foreign private banks reachedaround US$6.1 billion in 1996. However, as explained above, theline proved to be mostly unavailable when it was most needed.

18

Total Loss Maximumfor the Monthly Loss Standard DeviationBanking Duration of for the Banking Maximum Loss for of the Run in

First Month of System the Run System an Individual Bank Individual Banksthe Run2 (in percent) (in months) (in percent) (in percent) (in percent) Comments

December 1993 2.0 1 2.0 11.5 7.3November 1996 2.0 1 2.0 19.8 12.5August 1998 2.6 2 2.1 20.4 15.1 Impact of the Russian crisis.

December 1998 8.3 8 4.4 35.0 24.0 Impact of the Brazilian crisis. BancoRepublica was liquidated and BancoLatino was capitalized by COFIDE(public development financialinstitution).

May 2000 2.2 1 2.2 16.9 6.6 Impact of the election period.

August 2000 6.0 7 2.0 15.9 23.3 Impact of political instability precedingthe fall of the Fujimori administration.Two banks were closed—NuevoMundo and NBK Bank.

September 2001 5.0 6 2.2 29.0 30.9 Impact of political uncertainty and theArgentina crisis.

IV


Agenda for Prudential Reform

cases, the authorities' responses appear to be insuffi-cient in scope and content. Regarding solvency risk,the countries that are most often exposed seem to bethe ones less inclined to tighten their regulations.

No specific guidelines have yet been issued by theBasel Committee on Banking Supervision on how tocounteract credit risk exposure by banks in dollar-ized economies. Instead, substantial flexibilitywithin the legal and regulatory framework is given tosupervisors and banks on how to address these risks.In part, this may reflect the view that dollarizationdoes not introduce significant qualitative differencesto the nature of the risks banks face and the way inwhich these risks must be addressed. Differences, ifany, are seen as a matter of relative magnitude andemphasis. Dollarization risks must be taken intoaccount in the ongoing supervisory process, as partof the normal risk assessment and management dia-logue between supervisors and banks. Thus far, how-ever, such circumstances have not been viewed asrequiring fundamental adjustments of prudentialnorms. Consistent with this view, banks are expectedto be able to correctly assess the risks they face and,perhaps with some prodding from their supervisors,adequately manage them, taking into account theinherent tensions between risk reduction and the cor-responding costs entailed. As in any risk manage-ment strategy, the total elimination of risks may bedeemed to be too costly, keeping in mind the limitedprobability of large adverse shocks.

Specific features of many dollarized economiesmay call for a more aggressive prudential stanceagainst dollarization risks. The close associationbetween dollarization risks, the monetary and ex-change rate regime, and moral hazard argues in favorof more prudential activism. Because solvency risksderived from dollarization are systemic in nature,expectations of a government bailout in the event of acatastrophic exchange rate devaluation are wide-spread. To the extent that depositors expect a bailout,they have less incentive to require higher risk premi-ums on the deposits offered by the banks that lend pri-marily in dollars to local currency earners. In turn,because depositors will not reward them with lowerrisk premiums, bank shareholders have no incentive toadequately provide against such risks. Instead, theyare better off not offering such a provision because itallows them to limit their losses in the event of a cat-astrophic depreciation (e.g., it enhances the optionvalue of walking away). Bailout expectations similarlyinduce dollar borrowers to discount the real cost andrisks of dollar borrowing.28 By penalizing the more

prudent banks, competitive forces can help broadenacross all banks the failure of at least some of the par-ticipants to fully internalize risk.

Similar moral hazard failures affect banks' expo-sure to liquidity risk. The large international reservesheld by central banks and abundant associated provi-sion of liquidity support in the event of systemic runsprovide free insurance benefits. Banks thereforehave limited incentive to accumulate dollar liquidityon their own, if they know that all banks will be sim-ilarly affected and will need to be supported.29

Instead, competitive pressures will tend to penalizethose banks that set aside more liquidity or otherwisetake measures to limit the liquidity of their liabilities.


The main objective of a regulatory tighteningwould be to internalize risk. This should eliminatemoral hazard and level the playing field in favor ofthe local currency. In addition, it should increase thecapacity of dollarized financial systems to withstandliquidity or solvency shocks, thereby enhancing thescope for monetary and foreign exchange policy.However, as emphasized below, the degree of dollar-ization and the implications for financial intermedi-ation of a regulatory tightening, particularlyregarding the scope for regulatory arbitrage, alsoneed to be taken into account when implementingpolicy reform.

Solvency Risk

A flexible regulatory approach to limit currency-induced credit risk is preferable to one based on strictquantitative limits. As suggested by the observationof country practices, the range of options to managecurrency-induced credit risk is very broad, goingfrom doing nothing at one extreme to outright prohi-bition of foreign currency deposits or loans at theother extreme. Requiring banks to restrict their for-eign currency lending to fully hedged borrowers—naturally hedged by foreign currency revenue orfinancially hedged by using appropriate hedginginstruments—may be appropriate in countries wheredollarization is marginal or as a middle groundoption where tighter administrative restrictions on

28The moral hazard failure described above is compounded byfear of floating, as the monetary authorities, held hostage by highfinancial dollarization, may maintain a rigid exchange rate againstall odds, thereby increasing, in the end, the risk of a catastrophiccollapse.

29Indeed, the recent Ecuadoran experience, where sharp limitson liquidity support introduced in the wake of full dollarizationled banks to accumulate large liquid asset holdings abroad, pro-vides an interesting illustration of the impact of removing moralhazard. Along similar lines, Gonzalez-Eiras (2000) found that theintroduction in Argentina of a credit contingency line, to expandliquidity support to banks, led domestic banks to reduce theirdomestic liquidity relative to foreign banks (which were lessdependent on such support because of their increased reliance onsupport from parent banks).

19



financial dollarization are already in place and needto be relaxed to enhance the scope for financial inter-mediation. However, for countries that are alreadyhighly dollarized, this may drastically curtail thescope for domestic financial intermediation. Even ifthe growth of local currency intermediation is appro-priately encouraged and takes up some of the slack,it is unlikely to fully or rapidly substitute for dollarintermediation, in either volume or depth. Moreover,by limiting the scope for currency diversification inan increasingly integrated world, strict limits on dol-lar lending could thwart financial development andsound prudential management. By promoting off-shore intermediation, it could also hinder the finan-cial system's ability to manage and supervise risk.By encouraging the best borrowers to find alterna-tive sources of finance, it may, instead, have perverseeffects on the banking system's overall exposure tocredit risk. In the more developed financial systems,quantitative limits on dollarization are likely to bemostly ineffective because currency diversifica-tion will take place in other ways, notably throughderivatives.30

While a flexible approach that requires banks tointernalize risk but does not thwart sound risk man-agement is preferable, it raises important challenges.In particular, a proper instrument that is transparent,yet flexible, needs to be used. General provisions arepreferable to normal regulatory capital in that theyprovide a more flexible solvency buffer. Whengeneral provisions are not part of the minimum regu-latory capital, they can be used swiftly when need-ed—by converting them to specific provisions ascredits become delinquent—without putting thebank in a situation of prudential undercompliance,which would require immediate recapitalization andmight generate a credit crunch and an adverse mar-ket response.31 However, general provisions aremeant to be used for losses that have already beenrealized (although not yet fully identified). This isnot consistent with a value-at-risk approach thatseeks to identify the maximum losses that could beincurred under a worst-case scenario, within a givenconfidence interval. For this purpose, additional cap-

30For example, in Mexico (where dollar deposits are restricted),banks lend in "synthetic" dollars, based on peso funding and for-ward market hedging.

31Unlike capital requirements, general provisions smooth outthe credit cycle by providing a "speed bump" in times of rapidcredit growth and a "capital adequacy buffer" in the downwardphase of the credit cycle. General provisions are under discussionor have already been introduced by a number of countries (includ-ing Austria, Australia, Croatia, France, Greece, Portugal, andSpain), notwithstanding a lack, so far, of international agreementon their use. Objections have come from tax authorities (becauseof revenue losses if tax deducibility is allowed) and someaccounting bodies (on transparency grounds).

ital requirements in the form of specific reservesproportional to the excess value-at-risk assumed by abank when denominating loans to unhedged borrow-ers in foreign currency rather than in local currencyare indeed more appropriate. However, to ease theimpact of a large depreciation on the banking systemand limit the potential for a credit crunch, thesereserves should not be part of the regular capital ade-quacy requirements. Instead, transparent, preferablyrules-based, arrangements should be set up to allowthe reserves to be drawn down as warranted andgradually rebuilt once used. Adjusting the pace ofthe reserves buildup across time could have the addi-tional benefit of smoothing out the credit cycle and,hence, limiting the prudential risks arising from it.

Defining appropriate reserve needs can be diffi-cult in practice. The extent to which a borrower isunhedged requires a careful analysis of its cash flowunder large hypothetical changes in the exchangerate. This exercise requires analyzing the currencycomposition of a borrower's assets and liabilities aswell as the extent to which its revenues are likely tobe affected by an exchange rate depreciation.32 Let-ting banks define the reserves that need to be setaside for each loan, based on their own internal riskmodels and stress-test criteria provided by the super-visor, would be consistent with the second pillar ofthe Basel Capital Accord that emphasizes banks'own risk assessment and management practices.However, the systemic nature of such simulations, inwhich macroeconomic ripple effects are bound toplay an important role, may be difficult to reconcilewith the more micro-oriented, idiosyncratic ap-proach generally used by banks. Moreover, such anapproach would not be practical for the smaller loansand less-sophisticated banks or supervisory environ-ments. Thus, a first-pillar type of approach (i.e., aspecific capital charge) might be needed in many, ifnot most, cases. The supervisory authorities coulddirectly provide detailed reserve coefficients by typeof loan, based on a systemic value-at-risk approachthat identifies the maximum exchange rate deprecia-tion that might reasonably be expected and for whichprovision will be made.33 This approach should becomplemented by specific supervisory guidelines onhow to assess borrowers' ability to manage a foreign

32The currency in which a firm denominates its products doesnot provide, as such, any guarantee that its dollar-based incomewill be robust to exchange rate movements.

33This approach would implicitly recognize that banks are notexpected to be prepared to withstand real depreciations of exceed-ingly large size and small likelihood. The definition of an appro-priate value-at-risk cutoff would need to be based on amacroeconomic and statistical analysis of shocks and neededexchange rate responses.

IV

20



currency loan. In all cases, banks should disclose theextent of unhedged lending.

Regulatory adjustments to limit banks' directexposure to currency risk may also be needed. Thesupervisory authority could, for instance, recognizethe need to preserve capital by allowing for a long,structural, and open foreign exchange position notsubject to capital requirements and that reflects thecurrency composition of banks' balance sheets.However, symmetrical limits could be imposed onthe remaining foreign exchange position. In allcases, capital charges must be set on such foreignexchange positions.34

Liquidity Risk

With regard to liquidity risk, the aim should be toreduce the liquidity of banks' dollar liabilities andincrease that of dollar assets. Prudential regulationsto limit the risk of dollar liquidity crises need to startfrom the realization that local assets, such as short-term loans or treasury bills, can turn illiquid under asystemic crisis situation, unless they can be freelyused to obtain dollar liquidity from the central bank.Thus, a micro-oriented approach, such as maturitymatching of assets and liabilities, is not appropriateto manage liquidity risk on a systemic basis. Apreferable option is to generalize and, when appro-priate, increase currency-specific liquidity require-ments. The most liquid dollar liabilities should havethe highest backing against liquid dollar assets heldabroad or at the central bank or against dollar publicsecurities that can be rediscounted or used for repur-chase operations against the central bank's dollarreserves abroad (song, forthcoming). Liquidity ratioscan gradually decline as the maturity of banks' dol-lar liabilities lengthens.35 As in the case of provi-sioning requirements, a proper balance needs to befound between costs and risks.36

Strong assurances of support from a bank's parentgroup or readily available contingent lines of creditfrom first-line international banks might be ac-cepted, at least in part, as a substitute for holdingliquid assets abroad (Song, forthcoming). In the caseof branches of foreign banks, strong, legally bindingassurances of support from parent banks might beacceptable in lieu of liquid reserves when the parentbanks meet appropriate criteria, such as high ratings

by international rating agencies and sufficient size inrelation to their local branch.37 By adjusting the pol-icy response to the underlying risk, this should limitthe overall regulatory burden on the banking systemand therefore be less constraining to its developmentcapacity. However, by favoring the branches of largeinternational banks over indigenous banks, this couldhave broader consequences for the future of thebanking system that would need to be carefullyassessed.38

Dollar-lender-of-last-resort arrangements could beused to provide additional backstop liquidity supportto banks. Unlike liquidity requirements, lender-of-last-resort arrangements by central banks areexposed to moral hazard as they fail to internalizerisk and may further encourage dollarization byreducing the risks associated with dollar deposits.39

Yet, pooling external reserves at the central bankprovides some economies of scale that can lower theoverall cost of a foreign exchange liquidity buffer. Aproper balance between incentives and costs there-fore needs to be found in apportioning the liquiditybuffer between the central bank and the commercialbanks.40 In this context, the development of dollarpublic debt instruments that can be used for dollar-based monetary or foreign exchange operations canserve a useful purpose in highly dollarized countries.They can provide a means to recycle dollar liquidityand manage foreign reserves more effectively as wellas to increase the responsiveness of local dollar ratesto changes in risk perceptions, thereby limiting theneed for liquidity support from central banks.

Simultaneously, measures may also be needed topromote price responses to changes in asset demandsand to limit quantity adjustments. This can beachieved by promoting the secondary market tradingof long-term bank liabilities and other public orprivate securities. A loss of confidence (e.g., anincrease in country risk) can then be immediatelyreflected in asset prices, ensuring that they continueto be demanded. Moreover, asset holdings can bereshuffled from the more risk-averse investors to the

34Even when capital charges are set on foreign exchange posi-tions, it may still be necessary to impose limits on open foreignexchange positions as a percentage of capital. The latter areequivalent to high marginal capital requirements.

35Introducing a minimum holding period on dollar deposits canbe viewed as an extreme variation of differentiated liquidityrequirements.

36Box 4 presents such a calculation for Peru.

37Similar benefits might be given under similar conditions tothe fully owned subsidiaries of large international banks if thesubsidiary meets minimum commitment-enhancing criteria, suchas bearing the name of the parent, in addition to benefiting fromlegally binding assurances of support issued by the parent bank.

38The impact of increased foreign bank participation on theresilience and depth of banking systems is currently at the centerof an active ongoing debate. Note also that dollarization itselfmay already give foreign banks a competitive edge. See Swoboda(1968) for an early discussion of this issue.

39See Broda and Levy Yeyati (2003).40To further limit the moral hazard associated with the support

of dollar deposits, where deposit insurance is in place, higher pre-miums may be required on dollar deposits than on local currencydeposits.

21



less risk averse. In this context, regulations penaliz-ing early withdrawals of bank deposits or other bankinstruments and measures to help develop securiti-zation and mutual funds may also be needed topromote the growth of variable-price savings in-struments, such as securitized mortgages, mutualfund shares, and long-term certificates of deposit.Such measures should promote a gradual migrationof dollar short-term liabilities from banks to institu-tional investors. While mutual funds, pension funds,and other institutional investors may, at least infinancial markets with limited development, need toinvest a large share of their assets back into the bank-ing system, they are more susceptible to acquiringlonger-term instruments than the average individualinvestor.41

Measures to promote the development of special-ized foreign exchange hedges, such as forwards andoptions, may also be desirable. Similar hedging ben-efits can be obtained by replacing domestic dollarintermediation with local currency intermediation,complemented by a forward market in which in-vestors and borrowers take opposite positions. Themain benefit of using specialized risk instruments isthat it eliminates liquidity risk, albeit not counter-party risk. While derivatives are unlikely to developin nascent financial systems, they can take a pre-dominant role in more developed systems.42

Enhancing the Attractivenessof Local Currency

Measures to internalize the risks of intermediatingin foreign currency need to be reinforced by thosethat enhance the attractiveness of the local currencyand limit the risks associated with its use as an inter-mediation medium. To mitigate the costs of anaggressive prudential agenda to limit and internalizedollarization risks, the prudential reforms should beaccompanied by an equally aggressive agenda to

boost the attractiveness of the local currency, includ-ing its credibility and market acceptance. By lower-ing the costs and risks of intermediating in localcurrency, this can help promote a viable and moreresilient local-currency-based path of financialdevelopment. While the inherent difficulties inachieving sustained dedollarization should not beunderestimated, comprehensive measures that pro-mote the attractiveness of the local currency andsimultaneously internalize the risks of dollarization,by being mutually reinforcing, offer the best chancesof gradual success. Countries should, over time,experience a "virtuous cycle" in which dedollariza-tion enhances the scope for monetary autonomy,leading, in turn, to a further decline of dollarization.

A strong and visible commitment to protect thelong-term purchasing power of the currency shouldhelp enhance its credibility. This means that whenlocal inflation is high, relative to world inflation,above all else, further efforts will be made towardstabilization. However, as shown by the recent expe-rience of many highly dollarized countries, stabiliza-tion may not suffice to restore the credibility of thecurrency, at least within a reasonably short timespan. Confidence in the currency also implies reduc-ing the odds that the monetary authorities may againlose control of monetary policy in the future. Toaddress this problem, one option is to adopt a full-fledged inflation-targeting framework, backed by astrong and sustainable fiscal position.43 Yet to avoiddestabilizing expectations and, in a worst-case sce-nario, triggering a banking crisis induced by depositoutflows and a sharp exchange rate depreciation, achange in the monetary regime may need to be cau-tious and gradual, ensuring that proper conditionsare in place.

Measures to enhance the market acceptance of thelocal currency may also be needed. Direct financialrepression affecting the local currency, if in place,should be eliminated. This may include removingadministrative ceilings on local currency interest

41Admittedly, the scope for developing secondary markets forprivate financial instruments is more limited in less-developedfinancial systems. However, as Bolivia's experience suggests(where long-term bank deposits are actively traded in the stockexchange), secondary market trading of private instruments candevelop even in relatively simple financial systems.

42The scope for (and benefits of) derivative transactions such asforeign exchange forwards is limited in nascent markets by thelack of counterparties on the supply side of the market. Typically,banks that supply the forwards cover their position by buying for-eign exchange spot, thereby pressuring the market in the sameway as a straightforward purchase of foreign exchange. When for-wards are supplied by unhedged domestic market participants,counterparty risk increases as the capacity of counterparties tomeet the terms of the contract under a large devaluation becomesuncertain.

43Mishkin and Schmidt-Hebbel (2001) provide broad cross-country evidence in support of inflation targeting as a way to con-solidate confidence in the currency. The fact that countries thathave recently adopted an inflation-targeting framework, such asMexico, Poland, Hungary, and the Czech Republic, have madeprogress in containing or reducing dollarization also suggests thata strong anti-inflation commitment may have benefits for dedol-larization. However, it is too early to derive strong conclusionsfrom these experiences. Peru, which formally adopted an inflationtargeting framework in 2001, has seen some encouraging signspointing to increasing confidence in the local currency but has yetto experience a significant decline in financial dollarization.Moreover, some countries, such as Bosnia and Herzegovina,Lithuania, and Slovenia, also experienced declines or halts in dol-larization after having adopted strong stabilization policies,although these were not backed by formal inflation targeting.

IV

22


Enhancing the Attractiveness of Local Currency

rates, high unremunerated reserve requirements, orother forms of implicit or explicit taxation. There isindeed good evidence that such financial liberaliza-tion was at the root of Egypt's successful dedollari-zation.44 Measures to promote the developmentof the local currency money and bond marketsmay also be needed. This could require an effortto gradually develop markets for local-currency-denominated public securities, starting at the shorterend of the maturity structure. Consistent with thiseffort, the fiscal authorities must lead by example, interms of structuring debt in a way that reduces risk.They must be willing to accommodate somewhathigher debt-servicing costs, at least during a transitionperiod, and ensure the sustainability of the public debtunder potentially adverse exchange rate scenarios. Theeffort to promote the development of the money andbond markets in local currency may also need to beaccompanied by a strengthening of monetary manage-ment in local currency, aimed at smoothing out theday-to-day volatility of interest rates, consistent with agradual freeing of exchange rates. To promote marketdeepening and diversification, banks and other finan-cial intermediaries should be free to create their ownfinancial instruments, provided the resulting risks areadequately managed and reported.

The introduction or further promotion of price-indexed instruments can complement efforts to pro-mote local currency intermediation. While not fullyimmune to the prudential risks associated withabrupt changes in relative prices, such as changes inreal wages, price-indexed financial instruments cannonetheless provide a prudentially superior alterna-tive to dollar-denominated instruments for promot-ing financial deepening, particularly at the longermaturities.45 Moreover, they offer public debt man-agers a less risky alternative to dollar debt, which isalso less costly than nominal local-currency instru-ments. In Chile, after the 1982 crisis, the use of theUnidad de Fomento (UF)—a unit of account indexedto the consumer price index—helped to promoterapid financial reintermediation and deepening.

44See Baliño and others (1999).45Price indexation can also provide a superior alternative to

indexation through floating interest rates. While floating rateslimit inflation risk, they exacerbate interest rate risk. The use offloating-rate mortgages during the late 1990s in Colombia, wheredollarization is prohibited, was largely responsible for the finan-cial deterioration of the mortgage industry, as the very high inter-est rates associated with the defense of the currency during1998-99 were passed on to mortgage holders, leading them todefault en masse on their obligations. Brazil during the 1980s andearly 1990s provides another interesting example of the pitfalls oflimiting dollarization by regulation. The widespread use of theovernight interest rate to index most financial instruments gaverise to "indexed money," undermining monetary policy and wors-ening inflationary inertia.

However, the introduction of price-indexed instru-ments needs to be accompanied by a decisive effort tostabilize so as to avoid indexation in the real sector andmust be properly presented and explained so that it isnot taken as a signal of the government's lack ofresolve to fight inflation. It must also be gradual, notthe least because it must take place symmetrically onboth sides of banks' balance sheets.46 The successfuldevelopment of price-indexed instruments may alsorequire an aggressive issue of price-indexed publicsecurities to facilitate market development, a reform ofthe tax code to ensure tax neutrality, and a review of theprice index—in cases where the underlying consump-tion basket differs excessively from that of the averagedepositor, a CPI-indexed financial instrument may berelatively less attractive to the average investor than adollar-indexed instrument.47

Measures that enhance the quality of the paymentssystem in local currency can give it a competitiveedge over the dollar. The demand for local currencyinstruments can also be enhanced by improving thequality and reliability of the payments services pro-vided by the central bank. For example, good-qualitynotes and reliable, same-day check clearing in localcurrency can encourage bank customers to makepayments in local currency. Similarly, a reliable real-time gross settlement (RTGS) system in local cur-rency can facilitate wholesale payments and moneymarket transactions. When central banks are alreadyfaced with a large component of the payments sys-tem taking place in dollars—that is, when the dollarpayments system is systemically important, theymay, for risk management purposes, have to provideminimum payments services in dollars as well as inlocal currency, such as dollar settlement on the cen-tral bank's books.48 However, even in such cases, theuse of the local currency can still be encouragedthrough better service or lower fees.

46Asymmetric conversions into price-indexed instruments canotherwise give rise to a mismatch in banks' balance sheets that exac-erbates their vulnerability to interest rate risk. In Colombia, forexample, floating-rate mortgages were converted into price-indexedinstruments following the 1998-99 banking crisis. While the switchdid reduce borrowers' exposure to interest rate risk, it magnified thatof banks as most banks' liabilities continued to be expressed in pesosat very short maturities or with floating interest rates.

47In Bolivia, for example, the recently introduced Unidad deFomento de la Vivienda (UVF), which is indexed to the consumerprice index, reflects a consumption basket that is heavilyweighted toward basic staple goods. However, the ownershipstructure of bank deposits, which reflects the country's incomedistribution, is biased toward the higher income groups (nearly 50percent of deposits are above US$100,000), whose consumptionbaskets are intensive in imported goods.

48As long as proper arrangements are in place to ensure safesettlements and limit the central bank's exposure to settlementrisk, settling in dollars on the central bank's books is basicallyequivalent to settling in local currency from a risk managementperspective.

23



Box 5. Practical Safeguards and Countermeasures for Offshore Financial Centers

Bank supervisors are often constrained in theirattempts to tighten domestic prudential regulationsbecause funds could be diverted offshore to circumventthe regulations. Effective supervision of off shores maybe compromised, as supervisors are unaware of the truedimension of the activities undertaken. It is also oftendifficult to identify "sufficient evidence of control" toeffect consolidated supervision and some offshorestructures (parallel banks) are not usually subject toconsolidated supervision.

Consolidated supervision is often the basis forextending onshore regulations to offshore affiliates.Access to information has special relevance ininstances where a local financial institution has alicensed affiliate in an offshore jurisdiction, but whereaffiliate is actually managed from the home country anddoes not maintain a physical office in the jurisdiction.Parent financial institutions and parent supervisoryauthorities must be in a position to monitor risk expo-sure, including reputation risk, of the banks or bankinggroups for which they are responsible, based on thetotality of their business wherever it is conducted. Inthese situations, host country laws should permit thehome country supervisor to exercise effective consoli-dated supervision and to have access to the books andrecords of the affiliate that is legally licensed in an off-shore jurisdiction. In addition, the legal framework ofthe home country needs to allow home supervisors torequest uniform regulations to be applied to onshoreand offshore entities.

Evidence of control (the basis for consolidatedsupervision) between financial institutions is often dif-ficult to find. This problem arises not only when tryingto define the scope of a banking group but also in rela-tion to large exposures or when deciding if a "true sale"or a "true transaction" has taken place. Supervisorshave been encouraged to look at the core characteristicsof transactions rather than their legal structure. More-over, they should presume that there is some evidenceof control if transactions in the offshore financial centertake place at the local bank's premises or include thelocal bank's name in their own name. Sometimes thesolution adopted is to require that any equity invest-ment in an entity located in a country with a favorabletax system has to be a "control stake" and thereforesuch a subsidiary must be subject to consolidatedsupervision (e.g., Brazil).

Conditional licensing: Recognizing that for affiliatesoperating in offshore financial centers there is a higher

potential for restricted access to information, the homecountry supervisor should condition its authorization toestablish an affiliate in such a jurisdiction based on aclear understanding with the institution that it will grantaccess to information needed for supervisory purposes.

Punitive capital charge: As a measure to ensureaccess to books and records for affiliates licensed in anoffshore financial center, the home country supervisorcould impose a punitive capital charge against theinvestment to such an extent that access is prevented.For a particular investment, instead of the requirementthat the bank hold the minimum capital against theinvestment (e.g., 8 percent for many jurisdictions), thehome country could impose a 100 percent requirement,as is done in Brazil.

Parallel banks: By definition, parallel banks sharemanagement and/or ownership links with a financialinstitution in a home country. Given the potential forinappropriate activities, supervisors have moved toimpose a requirement that the bank in the home coun-try consolidate into its operations (on an accountingbasis) the activities of the parallel bank. Some supervi-sors either force a change in the group structure ordirectly include the parallel banks in the scope of con-solidated supervision (e.g., Spain). The result is that theparallel bank is treated as a subsidiary for supervisorypurposes and all typical consolidated supervisionrequirements would apply to the subsidiary.

Information sharing: As specified in Principle 25 ofthe Basel Core Principles for Effective Banking Super-vision, host country supervisors must have power toshare information needed by the home country super-visor for the purposes of carrying out consolidatedbanking supervision. Frequent arrangements includethe use of memoranda of understanding or exchange ofletters between supervisors that spell out clear pa-rameters for information sharing and the authority toconduct on-site inspections. In this case, informationon the asset side of the balance sheet poses fewer prob-lems than disclosure of depositor information. There isa growing perception that information primarilyrelated to liquidity (e.g., quantitative information ondeposit concentrations or some specific situationsinvolving a customer or groups of customers) shouldalso be easily accessible. National laws usually pre-vent disclosure of information on individual depositaccounts. In practice, home supervisors may obtaininformation through the parent bank or by examiningthe bank themselves.

Implementation Issues

Tightening prudential norms without encouragingthe growth of offshore or unregulated intermediationcan constitute a major challenge. Measures to fullyinternalize dollarization risk and build prudential

buffers might encourage the growth of unregulatedintermediaries, particularly offshores. When localbanks intermediate through offshore, rather thanthrough domestic, branches, the risks incurred bythe financial groups and the systemic exposure of thebanking system as a whole remain basically the

IV

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Implementation Issues

same. Yet the transparency of banks' financial state-ments and the reach of the supervisor are drasticallycurtailed. Indeed, the need to recover control on theirfinancial intermediaries led many countries withlarge offshore banks (including Costa Rica andGuatemala) to remove restrictions on domesticforeign-currency intermediation. Thus, a policyreversal toward tighter regulations will require thatways be found to limit the scope for regulatory arbi-trage. As described in Box 5, these usually involvemaking the authorization of the offshore branchesconditional upon a full consolidation with theironshore parents and the existence of comprehensiveinformation-sharing agreements with the supervi-sory authorities of the countries in which the off-shore branches are based.

The nature of the policy response to dollarizationis likely to depend on the degree of dollarization, itstrend, and the monetary and exchange regime. Incountries where inflation is low and monetary con-trol is good, where the possibility of an abruptregime change is remote because the exchange rate isalready flexible, and where dollarization is limitedand stable, there may not be a need to alter pruden-tial policies by much, if at all. In the intermediatecase of countries where dollarization is still limitedbut increasing—or could increase due to unstable, or

potentially unstable, monetary conditions or a moreopen capital account—a comprehensive, vigorous,and prompt policy agenda is needed, aimed ataddressing prudential issues raised by dollarization.The extreme case of heavily dollarized countrieswhere lack of currency credibility is deeply rootedcalls for a more careful and nuanced assessment ofthe nature, pace, and strategy of policy reform.

The pace and timing of implementation of pruden-tial reforms in highly dollarized countries needs to becarefully designed. In countries where most depositsand credit are in dollars, the necessary tightening ofprudential norms would imply, in many cases, largecapital additions and a reshuffling of banks' balancesheets. If implemented too abruptly, this could exertan excessive burden on banks, worsen their financialsituation, and lead to a credit crunch and a severefinancial disintermediation. In countries where credithas already declined and banks have incurred largelosses on their loans, following a slowdown in eco-nomic activity and exchange rate depreciations, sucha prudential tightening may need to be phased inmore gradually. Nonetheless, the opportunity to moti-vate the need for policy reform and to send a clear,up-front signal of forthcoming changes in policy ori-entations could be seized before the memories of therecent events fade away.

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V Conclusions

Dollarization can benefit the development anddeepening of financial systems in small coun-

tries or those with weak currencies, but it also posesunique financial risks that need addressing. Experi-ence shows that in bicurrency systems banks,investors and supervisors often do not sufficientlyrecognize or internalize the prudential risks associat-ed with foreign currency operations. This problemis particularly acute in countries where the exchangerate has been tightly managed for a long time, partlyout of concern for the potentially adverse conse-quences for the financial system of large exchangerate fluctuations.

This paper proposes a regulatory tightening tohelp address some of the specific risks of partiallydollarized economies. It outlines a set of prudentialmeasures, including special reserves against dollarloans to local currency-earning borrowers andcurrency-specific liquidity requirements that couldreduce banks' risk exposure and increase the cushionavailable to cover such risks.

This paper also argues that there would be defi-nite prudential advantages for dollarized countriesfrom taking measures to promote the use of localcurrency. Such measures should be taken at thesame time as the regulatory tightening is beingimplemented, because the regulatory measuresalone might be an excessive burden on financialintermediation. In particular, steps should be takento support the acceptance of the local currency asan intermediation medium, including through amore visible commitment to protect its purchasingpower and through structural measures to promotethe development of markets and instruments inlocal currency. Within this context, it is also worthstressing that the risk of banking crises in highly

dollarized economies, as in other economies, can belimited by sound macroeconomic policies and goodbank supervision.

The pace, nature, and extent of both prudential andmarket reforms are likely to be country specific anddiffer according to the degree of dollarization and itstrend. This paper argues that, to limit adjustmentcosts and risks, more gradual and careful policyreforms are probably called for in countries that arealready highly dollarized. Countries where dollariza-tion is still marginal but rising rapidly should takemore forceful and decisive actions.

Where crises do occur, dollarization may imposesevere constraints on the possible responses. Theabsence of an unlimited lender of last resort, coupledwith possibly more volatile deposits, will, in manycases, require more intense and, possibly more restric-tive, answers to bank runs. Clearly defined, market-friendly solutions are more likely to limit the costsassociated with the management of such crises andfacilitate the recovery of financial intermediation.

This paper's main recommendations are strictlypreliminary at this stage. Further debate is needed onboth the fundamental principles on which these rec-ommendations are based and the details of theiroperational implementation, which can be rathercomplex. The relevant international groupings, mostnotably the Basel Committee, and supervisors inhighly dollarized countries should be party to suchdebates. In view of the higher potential costs associ-ated with measures taken by countries in isolation, itis important that a broad consensus view on bestpractices emerge soon. The IMF could play animportant catalytic and advisory role in these discus-sions, both on a general conceptual level and on spe-cific issues of implementation.

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27


OCCASIONAL PAPERS

Recent Occasional Papers of the International Monetary Fund

230. Financial Stability in Dollarized Economies, by Anne-Marie Guide, David Hoelscher, Alain Ize, DavidMarston, and Gianni De Nicolo. 2004.

229. Evolution and Performance of Exchange Rate Regimes, by Kenneth S. Rogoff, Aasim M. Husain, AshokaMody, Robin Brooks, and Nienke Oomes. 2004.

228. Capital Markets and Financial Intermediation in The Baltics, by Alfred Schipke, Christian Beddies, Susan M.George, and Niamh Sheridan. 2004.

227. U.S. Fiscal Policies and Priorities for Long-Run Sustainability, Martin Muhleisen and Christopher Towe, edi-tors. 2004.

226. Hong Kong SAR: Meeting the Challenges of Integration with the Mainland, edited by Eswar Prasad, with con-tributions from Jorge Chan-Lau, Dora Iakova, William Lee, Hong Liang, Ida Liu, Papa N'Diaye, and TaoWang, 2004.

225. Rules-Based Fiscal Policy in France, Germany, Italy, and Spain, by Teresa Daban, Enrica Detragiache, Gabrieldi Bella, Gian Maria Milesi-Ferretti, and Steven Symansky. 2003.

224. Managing Systemic Banking Crises, by a staff team led by David S. Hoelscher and Marc Quintyn. 2003.

223. Monetary Union Among Member Countries of the Gulf Cooperation Council, by a staff team led by UgoFasano. 2003.

222. Informal Funds Transfer Systems: An Analysis of the Informal Hawala System, by Mohammed El Qorchi,Samuel Munzele Maimbo, and John F. Wilson. 2003.

221. Deflation: Determinants, Risks, and Policy Options, by Manmohan S. Kumar. 2003.

220. Effects of Financial Globalization on Developing Countries: Some Empirical Evidence, by Eswar S. Prasad,Kenneth Rogoff, Shang-Jin Wei, and Ayhan Kose. 2003.

219. Economic Policy in a Highly Dollarized Economy: The Case of Cambodia, by Mario de Zamaroczy and Sopan-haSa.2003.

218. Fiscal Vulnerability and Financial Crises in Emerging Market Economies, by Richard Hemming, Michael Kell,and Axel Schimmelpfennig. 2003.

217. Managing Financial Crises: Recent Experience and Lessons for Latin America, edited by Charles Collyns andG. Russell Kincaid. 2003.

216. Is the PRGF Living Up to Expectations?—An Assessment of Program Design, by Sanjeev Gupta, Mark Plant,Benedict Clements, Thomas Dorsey, Emanuele Baldacci, Gabriela Inchauste, Shamsuddin Tareq, and NitaThacker. 2002.

215. Improving Large Taxpayers' Compliance: A Review of Country Experience, by Katherine Baer. 2002.

214. Advanced Country Experiences with Capital Account Liberalization, by Age Bakker and Bryan Chappie. 2002.

213. The Baltic Countries: Medium-Term Fiscal Issues Related to EU and NATO Accession, by Johannes Mueller,Christian Beddies, Robert Burgess, Vitali Kramarenko, and Joannes Mongardini. 2002.

212. Financial Soundness Indicators: Analytical Aspects and Country Practices, by V. Sundararajan, Charles Enoch,Armida San Jose, Paul Hilbers, Russell Krueger, Marina Moretti, and Graham Slack. 2002.

211. Capital Account Liberalization and Financial Sector Stability, by a staff team led by Shogo Ishii and KarlHabermeier. 2002.

210. IMF-Supported Programs in Capital Account Crises, by Atish Ghosh, Timothy Lane, Marianne Schulze-Ghattas,Alesv Bulirv, Javier Hamann, and Alex Mourmouras. 2002.

209. Methodology for Current Account and Exchange Rate Assessments, by Peter Isard, Hamid Faruqee, G. RussellKincaid, and Martin Fetherston. 2001.

208. Yemen in the 1990s: From Unification to Economic Reform, by Klaus Enders, Sherwyn Williams, NadaChoueiri, Yuri Sobolev, and Jan Walliser. 2001.

207. Malaysia: From Crisis to Recovery, by Kanitta Meesook, Il Houng Lee, Olin Liu, Yougesh Khatri, NataliaTamirisa, Michael Moore, and Mark H. Krysl. 2001.

206. The Dominican Republic: Stabilization, Structural Reform, and Economic Growth, by a staff team led byPhilip Young, comprising Alessandro Giustiniani, Werner C. Keller, Randa E. Sab, and others. 2001.

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Occasional Papers

205. Stabilization and Savings Funds for Nonrenewable Resources, by Jeffrey Davis, Rolando Ossowski, JamesDaniel, and Steven Barnett. 2001.

204. Monetary Union in West Africa (ECOWAS): Is It Desirable and How Could It Be Achieved? by Paul Massonand Catherine Pattillo. 2001.

203. Modern Banking and OTC Derivatives Markets: The Transformation of Global Finance and Its Implications forSystemic Risk, by Garry J. Schinasi, R. Sean Craig, Burkhard Drees, and Charles Kramer. 2000.

202. Adopting Inflation Targeting: Practical Issues for Emerging Market Countries, by Andrea Schaechter, Mark R.Stone, and Mark Zelmer. 2000.

201. Developments and Challenges in the Caribbean Region, by Samuel Itam, Simon Cueva, Erik Lundback, JanetStotsky, and Stephen Tokarick. 2000.

200. Pension Reform in the Baltics: Issues and Prospects, by Jerald Schiff, Niko Hobdari, Axel Schimmelpfennig,and Roman Zytek. 2000.

199. Ghana: Economic Development in a Democratic Environment, by Sergio Pereira Leite, Anthony Pellechio,Luisa Zanforlin, Girma Begashaw, Stefania Fabrizio, and Joachim Harnack. 2000.

198. Setting Up Treasuries in the Baltics, Russia, and Other Countries of the Former Soviet Union: An Assessmentof IMF Technical Assistance, by Barry H. Potter and Jack Diamond. 2000.

197. Deposit Insurance: Actual and Good Practices, by Gillian G.H. Garcia. 2000.

196. Trade and Trade Policies in Eastern and Southern Africa, by a staff team led by Arvind Subramanian, withEnrique Gelbard, Richard Harmsen, Katrin Elborgh-Woytek, and Piroska Nagy. 2000.

195. The Eastern Caribbean Currency Union—Institutions, Performance, and Policy Issues, by Frits van Beek, JoseRoberto Rosales, Mayra Zermeno, Ruby Randall, and Jorge Shepherd. 2000.

194. Fiscal and Macroeconomic Impact of Privatization, by Jeffrey Davis, Rolando Ossowski, Thomas Richardson,and Steven Barnett. 2000.

193. Exchange Rate Regimes in an Increasingly Integrated World Economy, by Michael Mussa, Paul Masson,Alexander Swoboda, Esteban Jadresic, Paolo Mauro, and Andy Berg. 2000.

192. Macroprudential Indicators of Financial System Soundness, by a staff team led by Owen Evans, Alfredo M.Leone, Mahinder Gill, and Paul Hilbers. 2000.

191. Social Issues in IMF-Supported Programs, by Sanjeev Gupta, Louis Dicks-Mireaux, Ritha Khemani, CalvinMcDonald, and Marijn Verhoeven. 2000.

190. Capital Controls: Country Experiences with Their Use and Liberalization, by Akira Ariyoshi, Karl Habermeier,Bernard Laurens, Inci Otker-Robe, Jorge Ivan Canales Kriljenko, and Andrei Kirilenko. 2000.

189. Current Account and External Sustainability in the Baltics, Russia, and Other Countries of the Former SovietUnion, by Donal McGettigan. 2000.

188. Financial Sector Crisis and Restructuring: Lessons from Asia, by Carl-Johan Lindgren, Tomas J.T. Balino,Charles Enoch, Anne-Marie Guide, Marc Quintyn, and Leslie Teo. 1999.

187. Philippines: Toward Sustainable and Rapid Growth, Recent Developments and the Agenda Ahead, by MarkusRodlauer, Prakash Loungani, Vivek Arora, Charalambos Christofides, Enrique G. De la Piedra, PiyabhaKongsamut, Kristina Kostial, Victoria Summers, and Athanasios Vamvakidis. 2000.

186. Anticipating Balance of Payments Crises: The Role of Early Warning Systems, by Andrew Berg, EduardoBorensztein, Gian Maria Milesi-Ferretti, and Catherine Pattillo. 1999.

185. Oman Beyond the Oil Horizon: Policies Toward Sustainable Growth, edited by Ahsan Mansur and VolkerTreichel. 1999.

184. Growth Experience in Transition Countries, 1990-98, by Oleh Havrylyshyn, Thomas Wolf, Julian Berengaut,Marta Castello-Branco, Ron van Rooden, and Valerie Mercer-Blackman. 1999.

183. Economic Reforms in Kazakhstan, Kyrgyz Republic, Tajikistan, Turkmenistan, and Uzbekistan, by Emine Gur-gen, Harry Snoek, Jon Craig, Jimmy McHugh, Ivailo Izvorski, and Ron van Rooden. 1999.

182. Tax Reform in the Baltics, Russia, and Other Countries of the Former Soviet Union, by a staff team led by LiamEbrill and Oleh Havrylyshyn. 1999.

Note: For information on the titles and availability of Occasional Papers not listed, please consult the IMF's Publications Catalog or contact IMFPublication Services.

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Documents

Financial Stability in Dollarized Economies