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On The Spillover Of Exchangerate Risk Into Default Risk

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  • Miloš Božović
  • Branko Urošević
  • Boško Živković

Abstract

In order to reduce the exchange-rate risk, banks in emerging markets are typically denominating their loans in foreign currencies. However, in the event of a substantial depreciation of the local currency, the payment ability of a foreign-currency borrower may be reduced significantly, exposing the lender to additional default risk. This paper analyses how the exchange-rate risk of foreigncurrency loans spills over into default risk. We show that in an economy where foreigncurrency loans are a dominant source of financing economic activity, depreciation of the local currency establishes a negative feedback mechanism that leads to higher default probabilities, reduced credit supply, and reduced growth. This finding has some important implications that may be of special interest for regulators and market participants in emerging economies.

Suggested Citation

  • Miloš Božović & Branko Urošević & Boško Živković, 2009. "On The Spillover Of Exchangerate Risk Into Default Risk," Economic Annals, Faculty of Economics and Business, University of Belgrade, vol. 54(183), pages 32-55, October -.
    • Handle: RePEc:beo:journl:v:54:y:2009:i:183:p:32-55
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    References listed on IDEAS

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    1. Mr. Andre O Santos & Mr. Jorge A Chan-Lau, 2006. "Currency Mismatches and Corporate Default Risk: Modeling, Measurement, and Surveillance Applications," IMF Working Papers 2006/269, International Monetary Fund.
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    Cited by:

    1. Željko Jović, 2017. "Determinants Of Credit Risk – The Case Of Serbia," Economic Annals, Faculty of Economics and Business, University of Belgrade, vol. 62(212), pages 155-188, January -.
    2. Niepmann, Friederike & Schmidt-Eisenlohr, Tim, 2022. "Foreign currency loans and credit risk: Evidence from U.S. banks," Journal of International Economics, Elsevier, vol. 135(C).
    3. Mladen Stamenković, 2023. "Where Did All The Papers Go? A Bibliometric Overview Of Publications In Economics From Serbia," Economic Annals, Faculty of Economics and Business, University of Belgrade, vol. 68(236), pages 29-50, January –.
    4. Maxim Nikitin & Branko Urošević, 2022. "Globalisation, Exchange Rate Regimes, and Financial Contagion," Russian Journal of Money and Finance, Bank of Russia, vol. 81(4), pages 3-33, December.
    5. Petar Marković & Branko Urošević, 2011. "Market Risk Stress Testing For Internationally Active Financial Institutions," Economic Annals, Faculty of Economics and Business, University of Belgrade, vol. 56(188), pages 62-90, January –.
    6. Dejan Šoškić, 2015. "Inflation Targeting Challenges In Emerging Market Countries: The Case Of Serbia," Economic Annals, Faculty of Economics and Business, University of Belgrade, vol. 60(204), pages 7-30, January –.

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    More about this item

    Keywords

    foreign currency loans; exchange-rate risk; default risk; banking regulation; integrated risk analysis;
    All these keywords.

    JEL classification:

    • E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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