Working Paper: CEPR ID: DP8250
Authors: Romain Rancière; Aaron Tornell; Athanasios Vamvakidis
Abstract: This paper constructs a new measure of currency mismatch in the banking sector that controls for bank lending to unhedged borrowers. This measure explicitly takes into account the indirect exchange rate risk that banks undertake when they lend to borrowers that will notbe able to repay in the event of a sharp depreciation. Such systemic risk taking is not captured by indicators that are based only on banks? balance sheet data. The new measure is constructed for 10 emerging European economies and for a broader sample that includes 19 additional emerging economies, for the period 1998-2008. Comparisons with previous currency mismatch measures that do not adjust for unhedged foreign currency borrowing illustrate the advantages of the new approach. In particular, the new measure flagged the indirect currency mismatch vulnerabilities that were building up in a number of emerging economies before the recent global crisis. Measuring currency mismatch more accurately can help country authorities in their efforts to address vulnerabilities at the right time, avoiding hurting growth prospects.
Keywords: currency mismatch; emerging economies; financial crises; systemic risk
JEL Codes: E44; F34; G15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| traditional measures of currency mismatch (F31) | systemic risk (E44) |
| new measure of currency mismatch (F31) | systemic risk (E44) |
| unhedged foreign currency lending (F31) | systemic risk (E44) |
| currency mismatch (F31) | nonperforming loans (G21) |
| currency devaluation (F31) | nonperforming loans (G21) |
| currency mismatch (F31) | stability of the banking system (G21) |
| currency mismatch (F31) | broader economy stability (E66) |