Foreign currency banking in East Asia and the lender of last resort Presentation to a Conference on Dollarization and Euroization, Sponsored by the International Financial Stability Programme, Centre for Economic Performance & FMG London School of Economics, May 2002 by Robert N. McCauley Deputy Chief Representative Representative Office for Asia and the Pacific, Hong Kong SAR Bank for International Settlements

2 BIS Asian Office Opened in July 1998 in Hong Kong SAR. 13 staff, including bankers, economists, risk manager and administrators. Provides banking services to Asian and Pacific central banks. Four economists, including one regulatory economist with Basel Committee experience. Work on foreign currency banking in East Asia joint with Ben Fung and Guonan Ma.

3 Dollarisation vs. the lender of last resort Central bank in dollarised system can serve as lender of last resort only to the extent “free” forex reserves and unused credit lines. Thus, bank runs and flight into (foreign) currency can become more destabilising. Monetary stability but financial instability? Particular form of general problem of liquidity support in foreign currency to banking system with substantial foreign currency book (aka “financial dollarization” --Levy & Sturnzenegger).

4 Last resort lending in foreign currency In Nordic banking crisis, Riksbank and Bank of Norway in effect lent dollars to Swedish and Nor. banks to meet interbank run in dollars and DM. Bank of Korea placed reserves with Korean banks losing interbank dollar deposits in If forex swap markets working, domestic liquidity can be swapped for foreign currency (as in Japan premium episodes), but credit concerns may block. Global (vs inter’l banking)--use of local currency outside home market--widening potential call.

5 Foreign currency banking in East Asia Foreign currency deposits have expanded substantially in recent years, especially when and where US dollar yields above local yields. At end-2000, foreign currency deposits amounted to $530 billion in 10 economies in East Asia (more than euro area or UK). As share of broad money, less than 5% in Thailand, 5-10% in China, Korea, Malaysia and Taiwan, 10-50% in Indonesia, Philippines and Singapore and over 50% in Hong Kong & Macao

6 How the authorities can meet liquidity needs in forex Prevent: low loan to deposit ratio; match maturity of forex assets and liabilities Import access to liquidity: Let foreign banks play substantial role in banking system. Maintain large official foreign exchange reserves: back foreign currency activity of domestic banks with officially held foreign exchange.

7 E Asian banks very liquid in dollars While foreign currency deposits have expanded, corporations have paid down dollar debts. Pay-down of dollar loans reflects –Strong cash flows relative to investment (reflected in current account surpluses). –Bad memory of liability blow-outs resulting from depreciation of local currencies in Asian crisis (compare IT, SE corporations post 1992). –Low domestic interest rates. Eg, loan/deposit ratio fell from 1.3 to 0.7 in China.

8 Foreign currency loans & deposits of Chinese banks in China Billions of US dollars Sources: People’s Bank of China; authors’ estimates.

9 Role of foreign banks in E Asia varies Foreign banks as shield against crisis overstated? Does legal form—subsidiary vs branch—matter? In some economies, foreign banks play large role in foreign currency banking: Hong Kong, Malaysia. In others, local banks have high and rising share of foreign currency banking: Taiwan. In China, under WTO foreign banks to increase their small share of foreign currency banking. Although entry into ID, KR, TH through acquisition of distressed banks after crisis, foreign bank share lower in Asia than in E Europe or Latin America.

10 E Asian banks central banks have built foreign exchange reserves Motivation –To manage exchange rate. –To improve national liquidity in general and to back-stop short-term bank liabilities in particular. Reserves have grown by over 50% since end-1998 in East Asia ex-Japan. Region now has almost 40% of world reserves.

11 Official foreign exchange reserves Billions of US dollars

12 Conclusions I.Foreign currency, mostly dollar, deposits in E Asia have grown rapidly amid low inflation and yields. II.Strong corporate cash flows and corresponding current account surpluses have led to pay-down of foreign currency debts. III.Asian banks thus generally highly liquid in dollars. IV.Therefore, prevention (self-insurance) limits potential demand for lender of last resort in foreign currency. V.Official foreign exchange reserves back-stop foreign-exchange liquidity of Asian banks.

13 References Fung, Ben S C, and Robert N McCauley, “Analysing the growth of Taiwanese deposits in foreign currency”, BIS Quarterly, September 2001 ( Levy-Yeyati, Eduardo, and Federico Sturzenegger, “Dollarization: A Primer”, introductory chapter, Dollarization (MIT Press: forthcoming). Ma, Guonan, and Robert N McCauley, “Following Chinese banks’ foreign currency liquidity”, BIS Quarterly, June Robert N McCauley, Judith S Ruud and Philip Wooldridge, “Globalising international banking”, BIS Quarterly, March 2002.