A New Index of Currency Mismatch and Systemic Risk

26 Pages Posted: 1 Feb 2011

See all articles by Romain G. Rancière

Romain G. Rancière

University of Southern California

Aaron Tornell

University of California, Los Angeles (UCLA) - Department of Economics; National Bureau of Economic Research (NBER); CESifo (Center for Economic Studies and Ifo Institute)

Athanasios Vamvakidis

International Monetary Fund (IMF) - European Department

Date Written: November 2010

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 not be 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: Banking sector, Cross country analysis, Currencies, Economic models, Emerging markets, Europe, External borrowing, Financial crisis, Fiscal risk, Loans, Sovereign debt, Time series

Suggested Citation

Rancière, Romain G. and Tornell, Aaron and Vamvakidis, Athanasios, A New Index of Currency Mismatch and Systemic Risk (November 2010). IMF Working Papers, Vol. , pp. 1-25, 2010. Available at SSRN: https://ssrn.com/abstract=1751375

Romain G. Rancière

University of Southern California ( email )

2250 Alcazar Street
Los Angeles, CA 90089
United States

Aaron Tornell

University of California, Los Angeles (UCLA) - Department of Economics ( email )

Box 951477
Bunche Hall 8387
Los Angeles, CA 90095-1477
United States
310-794-1686 (Phone)
310-825-9528 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

Athanasios Vamvakidis

International Monetary Fund (IMF) - European Department ( email )

700 19th Street NW
Washington, DC 20431
United States

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