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Endogenous deposit dollarization

  • Christian Broda
  • Eduardo Levy Yeyati

This paper explores sources of deposit dollarization unrelated to standard moral hazard arguments. We develop a model in which banks choose the optimal currency composition of their liabilities. We argue that the equal treatment of peso and dollar claims in the event of bank default can induce banks to attract dollar deposits above the socially desirable level. The distortion arises because dollar deposits are the only source of default risk in the model, but dollar depositors share the burden of the default with peso depositors. The incentive to dollarize is reinforced by common banking system safety nets such as deposit and bank insurance. Our findings suggest that regulators in bi-currency economies would potentially benefit by departing from the currency-blind benchmark and differentiating among currencies in a way that prevents undesirable currency mismatches.

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Paper provided by Federal Reserve Bank of New York in its series Staff Reports with number 160.

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Date of creation: 2003
Date of revision:
Handle: RePEc:fip:fednsr:160
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  1. Michael P. Dooley, 1998. "A model of crises in emerging markets," International Finance Discussion Papers 630, Board of Governors of the Federal Reserve System (U.S.).
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  4. Craig Burnside & Martin Eichenbaum & Sergio Rebelo, 1998. "Prospective Deficits and the Asian Currency Crisis," NBER Working Papers 6758, National Bureau of Economic Research, Inc.
  5. Sergio L. Schmukler & Luis Serven, 2002. "Pricing Currency Risk: Facts and Puzzles from Currency Boards," NBER Working Papers 9047, National Bureau of Economic Research, Inc.
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  12. Craig Burnside & Martin Eichenbaum & Sergio Rebelo, 1999. "Hedging and Financial Fragility in Fixed Exchange Rate Regimes," NBER Working Papers 7143, National Bureau of Economic Research, Inc.
  13. Uribe, Martin, 1997. "Hysteresis in a simple model of currency substitution," Journal of Monetary Economics, Elsevier, vol. 40(1), pages 185-202, September.
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  15. Alexander Kyei, 1995. "Deposit Protection Arrangements: A Survey," IMF Working Papers 95/134, International Monetary Fund.
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