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, 24-25 May 2002by

Robert N. McCauley

Deputy Chief Representative

Representative Office for Asia and the Pacific, Hong Kong SAR

Bank for International Settlements

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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.

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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).

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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 1997.

• 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.

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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

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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.

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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.

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Foreign currency loans & deposits of Chinese banks in ChinaBillions of US dollars

50

100

150

1998 1999 2000 2001

Loans Deposits

Sources: People’s Bank of China; authors’ estimates.

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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.

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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.

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Official foreign exchange reserves Billions of US dollars

1998 2001

E Asiaex-JP

563 34% 771 38%

Japan 203 12% 388 19%

Total 1638 100% 2022 100%

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ConclusionsI. 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.

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References• Fung, Ben S C, and Robert N McCauley, “Analysing the growth of

Taiwanese deposits in foreign currency”, BIS Quarterly, September 2001 (www.bis.org).

• 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 2002.

• Robert N McCauley, Judith S Ruud and Philip Wooldridge, “Globalising international banking”, BIS Quarterly, March 2002.