Addressing private sector currency mismatches in emerging Europe

This paper provides a survey of the theoretical and empirical literature on the dollarisation of corporate and household liabilities; presents evidence on the causes of FX lending specifically in transition economies; and proposes a set of criteria to help decide on the right policy response based on country characteristics. These criteria particularly affect the extent to which regulation should be part of the policy response. Regulation to contain FX mismatches is useful in relatively advanced countries in which small market size and/or proximity to the euro make it difficult to fully develop local currency capital markets. In contrast, regulatory responses could be counterproductive in less advanced countries with high macroeconomic volatility. In these countries, the route to de-dollarisation first and foremost requires the strengthening of macroeconomic institutions.

Foreign banks and foreign currency lending in emerging Europe

Based on survey data from 193 banks in 20 countries we provide the first bank-level analysis of the relationship between bank ownership, bank funding and foreign currency (FX) lending across emerging Europe. Our results contradict the widespread view that foreign banks have been driving FX lending to retail clients as a result of easier access to foreign wholesale funding. Our cross-sectional analysis shows that foreign banks do lend more in FX to corporate clients but not to households. Moreover, we find no evidence that wholesale funding had a strong causal effect on FX lending for either foreign or domestic banks. Panel estimations show that the foreign acquisition of a domestic bank does lead to faster growth in FX lending to households. However, this is driven by faster growth in household lending in general not by a shift towards FX lending.Foreign banks; FX lending; financial integration; Emerging Europe

Foreign Currency Borrowing by Small Firms

We examine the firm- and country-level determinants of the currency denomination of small business loans. We first model the choice of loan currency in a framework which features a trade-off between lower cost of debt and the risk of firm-level distress costs, and also examines the impact of information asymmetry between banks and firms. When foreign currency funds come at a lower interest rate, all foreign currency earners as well as those local currency earners with high revenues and low distress costs choose foreign currency loans. When the banks have imperfect information on the currency and level of firms revenues, even more local earners switch to foreign currency loans, as they do not bear the full cost of the corresponding credit risk. We then test the implications of our model by using a 2005 survey with responses from 9,655 firms in 26 transition countries. The survey contains details on 3,105 recent bank loans. At the firm level, our findings suggest that firms with foreign currency income and assets are more likely to borrow in a foreign currency. In contrast, firm-level distress costs and financial transparency affect the currency denomination only weakly. At the country level, the interest rate advantages of foreign currency funds and the exchange rate volatility do not explain the foreign currency borrowing in our sample. However, foreign bank presence, weak corporate governance and the absence of capital controls encourage foreign currency borrowing. All in all, we cannot confirm that "carry-trade behavior" is the key driver of foreign currency borrowing by small firms in transition economies. Our results do, however, support the conjecture that banking-sector structures and institutions that aggravate information asymmetries may facilitate foreign currency borrowing.foreign currency borrowing, competition, banking sector, market structure

Foreign Currency Lending in Emerging Europe: Bank Level Evidence

Based on survey data from 193 banks in 20 countries we provide the first bank-level analysis of the determinants of foreign currency (FX) lending in Emerging Europe. We find that FX lending by all banks, regardless of their ownership structure, is strongly determined by the macroeconomic environment. We find no evidence of foreign banks ‘pushing’ FX loans indiscriminately because of easier access to wholesale funding in foreign currency. In fact, while foreign banks do lend more in FX to corporate clients, they do not do so to retail clients. We also find that after a take-over by a foreign bank, the acquired bank does not increase its FX lending any faster than a bank which remains in domestic hands.Foreign currency lending;currency mismatch;foreign banks;financial stability

The impact of the global economic and financial crisis on central, eastern and south-eastern Europe: A stock-taking exercise

The paper first reviews the main drivers of the growth and real convergence process in central, eastern and south-eastern Europe (CESEE) since 2000 and assesses the key macro-financial strengths and vulnerabilities of the region at the beginning of the global economic and financial crisis. The main part of the paper reviews financial and real economic developments in these countries since the crisis started to impact the CESEE region. The paper finds that developments have been rather heterogeneous in the region. CESEE countries with the largest economic imbalances tended to be most affected. National and international support measures appear to have helped to stabilise financial markets, and parent banks of foreign bank subsidiaries in CESEE were committed to sustaining their exposure to the region. The degree to which CESEE governments were able to use policy instruments to counter the real effects of the crisis is rather heterogeneous, depending inter alia on the exchange rate regime in place and the initial fiscal positions. JEL Classification: E52, E58, E44central, eastern and south-eastern Europe, financial crisis, vulnerability indicators

CURRENT ACCOUNT SUSTAINABILITY IN SELECTED TRANSITION COUNTRIES

The article examines the question of whether the current account deficits seen in selected transition economies in recent years mainly as a symptom of the dynamic economic activity of the catching-up process are a source of potential macroeconomic destabilisation. Given the possible significant reduction of capital flows, as well as restrictions and lessons from recent financial crises, current account deficits must be closely monitored in the region. In this respect, the issue of 'current account sustainability’ in seventeen transition economies is investigated. For this purpose, two accounting frameworks (Milesi-Ferreti and Razin, 1996; Reisen, 1998) based on certain strict assumptions are employed. The results show that if the observed level of foreign direct investment (FDI) flows is kept in the medium run almost all countries could optimally have a higher level of external deficit, with the exception of countries such as Baltic States, Hungary, Macedonia, Moldova and Romania. Accordingly, the maintenance of relatively large FDI inflows (especially greenfield investments) to national economies is a key priority in securing future external sustainability. In the end, the results indicate that current account deficits of transition economies that exceed 5 percent of GDP generally involve problems of their external sustainability.http://deepblue.lib.umich.edu/bitstream/2027.42/57224/1/wp844 .pd

Asymmetric Information and the Foreign-Exchange Trades of Global Custody Banks

This paper provides the first rigorous empirical analysis of markups on custodial foreign exchange trades. It finds that they substantially exceed relevant benchmarks such as interbank half-spreads. We trace this to an information asymmetry -- custodial bank dealers know more about their prices and bid-ask spreads than their client funds. We also examine the asset managersÂ’ continued heavy reliance on this high-cost approach to trading when alternatives are available with lower markups. We provide evidence that this choice does not reflect ignorance of the cost differential. Analysis relies on the complete foreign exchange trading record of a mid-sized global custody bank during calendar year 2006.

Finding a balance between growth and vulnerability trade-offs : lessons from emerging Europe and the CIS

This paper examines the growth patterns of emerging Europe and the Commonwealth of Independent States (CIS) countries prior to the global financial crisis. The aim is to draw lessons on what policies can best position these countries going forward to enjoy growth without a buildup in macro and financial vulnerability. Cluster analysis is used to classify these countries across the growth and vulnerability dimensions; namely, a classification into low or high growth outcomes, each of which may occur with low or high vulnerability features. The vulnerability indicators used are multifaceted, covering both the domestic and the external dimensions that have been identified in previous studies as being good indicators of likelihood of crisis -- itself understood as multidimensional. Based on multinomial logit regressions, the initial conditions and the economic policies that might affect the probabilities of being in each of the four possible cluster combinations are examined. Many (if not most) of the countries in the sample experienced very large capital inflows relative to their gross domestic product prior to the crisis, which can complicate macroeconomic management and lead to a buildup of vulnerability. These large inflows were partly due to the high liquidity in global markets and, at least for some countries in the country sample, the particular attractiveness of"new Europe and emerging countries in the region"in the eyes of foreign investors. Nonetheless, the analysis finds strong evidence that the macroeconomic and structural policies that over time influence the structure of the economy, can play a significant role in explaining (and, going forward, in influencing) the different growth and vulnerability patterns experienced by the countries covered in this paper.Currencies and Exchange Rates,Debt Markets,Economic Theory&Research,Achieving Shared Growth,Economic Conditions and Volatility

Credit growth in emerging Europe : a cause for stability concerns?

High credit growth in Emerging Europe, generally considered a sign of catching-up with the"old"Europe, has begun receiving considerable attention among investors and policymakers alike. Given heightened global risks and the demands under the European Union accession process, the need to better understand this high credit growth's drivers, riskiness, and the possible macroeconomic and financial stability consequences is strong. The authors adopt a holistic approach in reviewing the rapid credit growth experienced in the region, examining macroeconomic, financial sector, corporate sector, and asset market consequences and possible vulnerabilities. They consider three possible scenarios-a catching-up with older European countries, a soft landing as experienced by Portugal in the early 2000s, and a hard landing as experienced by Asia in 1997.Banks&Banking Reform,Financial Intermediation,Financial Crisis Management&Restructuring,Economic Theory&Research,Investment and Investment Climate