Financial Dollarization: The Role of Banks and Interest Rates

TLDR

Expanding on the existing literature, the framework allows interest rate differentials to play a role in explaining financial dollarization. This paper develops a model to explain the determinants of financial dollarization. The authors construct a model that incorporates interest rate differentials and foreign bank presence, and apply it to a newly compiled dataset on transition economies. The empirical analysis shows that greater foreign fund access raises credit dollarization but reduces deposit dollarization, that interest rate differentials influence both loan and deposit dollarization, and that these results support the model’s predictions.

Abstract

This paper develops a model to explain the determinants of financial dollarization. Expanding on the existing literature, our framework allows interest rate differentials to play a role in explaining financial dollarization. It also accounts for the increasing presence of foreign banks in the local financial sector. Using a newly compiled data set on transition economies we find that increasing access to foreign funds leads to higher credit dollarization, while it decreases deposit dollarization. Interest rate differentials matter for the dollarization of both loans and deposits. Overall, the empirical results lend support to the predictions of our theoretical model.