Foreign currency banking in East Asia and the lender of last resort

1. 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 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 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.

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 ChinaBillions 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 • Foreign currency, mostly dollar, deposits in E Asia have grown rapidly amid low inflation and yields. • Strong corporate cash flows and corresponding current account surpluses have led to pay-down of foreign currency debts. • Asian banks thus generally highly liquid in dollars. • Therefore, prevention (self-insurance) limits potential demand for lender of last resort in foreign currency. • 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 (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.