Financial dollarization: the role of banks and interest rates

TLDR

Interest rate differentials are known to influence financial dollarization. This paper develops a model to explain the determinants of financial dollarization. The model incorporates interest rate differentials and the growing role of foreign banks in the local financial sector. Empirical results show that greater access to foreign funds increases credit dollarization but reduces deposit dollarization, and that interest rate differentials affect both loans and deposits, supporting the model. JEL Classification: (not specified).

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. JEL Classification: