Behind Dollar Savings in Mutual Funds: Are Shifting Sands Threatening Financial Stability?

Abstract

I unveil the predominance of mutual funds in dollar-denominated savings of emerging markets and explore its consequences for global financial stability. I uncover that they primarily intermediate between households and banks in both domestic and foreign countries by arbitraging deposit rate differentials, which annually yield households 0.3% more than local banks. I identify a trade-off in the impact on the domestic country's financial stability: On the one hand, banks are less exposed to exchange rate risk because a sizable share of dollar savings is invested abroad. On the other hand, mutual funds are significant term-deposit holders, which makes banks more prone to runs. Using a meaningful mutual fund redemption event, I found that banks raise their lending rates, sold dollar securities, and slightly engaged in risk-taking behavior. For foreign countries, it generates limited financial stability spillovers: most of the capital flows as uninsured deposits to USD-using countries, is allocated in small banks, and, since mutual funds diversify across countries, their share in each financial system is small. Using model insights, an implication for deposit de-dollarization policies is that they unintentionally shift savings from banks toward mutual funds, but indirectly reduce the deposit runnability risk due to mutual fund redemptions.