Currency Loans Research Articles

Hugleiðingar um peningamálastefnu

Í ritgerð þessari er umgerð stjórnar peningamála árin 2001-2008 lýst, farið yfir þá veikleika sem komu í ljós á þessum árum og lagðar til breytingar sem ætlað er að koma í veg fyrir að stjórnvöld missi stjórn á efnahagslífinu aftur. Lagt er til að bæði stjórntækjum og markmiðum Seðlabankans verði fjölgað. Þannig muni hann leitast við að hemja aukningu útlána bankakerfisins og skuldsetningu einkaaðila í framtíðinni auk þess sem hann reyni að ná verðbólgumarkmiði sínu. Gerðar verði breytingar á húsnæðislánakerfinu þannig að vextir á húsnæðislánum verði háðir vöxtum Seðlabankans og útlán í erlendri mynt til aðila sem hafa tekjur í krónum verði bönnuð. Jafnframt hækki yfirvöld peningamála lágmark eiginfjarhlutfalls viðskiptabanka ef þeir eru orðnir svo stórir að fjármálastöðugleika er ógnað eða hafa stækkað of ört; unnt sé að skattleggja stutt lán viðskiptabanka og einnig leggja skatt á lántökur einstaklinga og fyrirtækja og/eða umbuna þeim sem greiða niður skuldir sínar; lækka hámarkshlutföll lána af kaupverði fasteigna í uppsveiflu og Seðlabankinn grípi inn í gjaldeyrismarkaði til þess að jafna gengissveiflur. Jafnframt er lagt til að viðskiptabönkum verði bannað að reka fjárfestingastarfsemi.

Ryzyko kredytów walutowych i metody jego ograniczania na polskim rynku finansowym

In the last several years currency loans have become one of the most important source of financing of households and enterprises in Poland. They are particularly used for real estates investments, where their prevalent form is a forward mortgage. In practice currency loans are long-term obligations which create significant risks such as: foreign interest-rate risk, fx risk, and spread risk within a few dozen years. Such risks can strongly influence the stability of whole Polish banking sector as well as financial market in Poland. As currency loans are mostly used by households there are very limited ways of managing the mentioned kinds of risk. Because the share of currency loans is at present still dynamically increasing in the banking system, the aim of this paper is to characterize mentioned loans and to present their significance in Poland, as well as risks related to them. Normal 0 21 false false false PL X-NONE X-NONE /* Style Definitions */ table.MsoNormalTable {mso-style-name:Standardowy; mso-tstyle-rowband-size:0; mso-tstyle-colband-size:0; mso-style-noshow:yes; mso-style-priority:99; mso-style-parent:; mso-padding-alt:0cm 5.4pt 0cm 5.4pt; mso-para-margin-top:0cm; mso-para-margin-right:0cm; mso-para-margin-bottom:10.0pt; mso-para-margin-left:0cm; line-height:115%; mso-pagination:widow-orphan; font-size:11.0pt; font-family:Calibri,sans-serif; mso-ascii-font-family:Calibri; mso-ascii-theme-font:minor-latin; mso-hansi-font-family:Calibri; mso-hansi-theme-font:minor-latin; mso-bidi-font-family:Times New Roman; mso-bidi-theme-font:minor-bidi; mso-fareast-language:EN-US;} In the last several years currency loans have become one of the most important source of financing of households and enterprises in Poland. They are particularly used for real estates investments, where their prevalent form is a forward mortgage. In practice currency loans are long-term obligations which create significant risks such as: foreign interest-rate risk, fx risk, and spread risk within a few dozen years. Such risks can strongly influence the stability of whole Polish banking sector as well as financial market in Poland. As currency loans are mostly used by households there are very limited ways of managing the mentioned kinds of risk. Because the share of currency loans is at present still dynamically increasing in the banking system, the aim of this paper is to characterize mentioned loans and to present their significance in Poland, as well as risks related to them. Normal 0 21 false false false PL X-NONE X-NONE /* Style Definitions */ table.MsoNormalTable {mso-style-name:Standardowy; mso-tstyle-rowband-size:0; mso-tstyle-colband-size:0; mso-style-noshow:yes; mso-style-priority:99; mso-style-parent:; mso-padding-alt:0cm 5.4pt 0cm 5.4pt; mso-para-margin-top:0cm; mso-para-margin-right:0cm; mso-para-margin-bottom:10.0pt; mso-para-margin-left:0cm; line-height:115%; mso-pagination:widow-orphan; font-size:11.0pt; font-family:Calibri,sans-serif; mso-ascii-font-family:Calibri; mso-ascii-theme-font:minor-latin; mso-hansi-font-family:Calibri; mso-hansi-theme-font:minor-latin; mso-bidi-font-family:Times New Roman; mso-bidi-theme-font:minor-bidi; mso-fareast-language:EN-US;}

Substitution Between Domestic and Foreign Currency Loans in Central Europe. Do Central Banks Matter?

In this paper we ask a question about the impact of monetary policy on total bank lending in the presence of a developed market for foreign currency denominated loans and potential substitutability between domestic and foreign currency loans. Our results, based on a panel of three biggest Central European countries (the Czech Republic, Hungary and Poland) confirm the existence of the substitution effect between these loans. Restrictive monetary policy leads to a decrease in domestic currency lending but simultaneously accelerates foreign currency denominated loans. This makes the central bank's job harder with respect to providing both, monetary and financial stability.

Forging New Global Alliances: Emerging Markets and Advanced Economies

Forging new global alliances or new legal and institutional frameworks through international cooperation could help solve the 2007–2009 financial crisis by addressing the most vulnerable aspects of the current financial system and infrastructure. These aspects are liquidity, which is at the heart of the stability of the financial system; trust and transparency, with better disclosure of banks’ institutional arrangements for risk management, risk models, and techniques; and consolidation of the infrastructure of financial markets. At the same time, international cooperation, although difficult to achieve, could reduce the volatility of emerging markets and their overdependence on foreign currency loans that lead to increased defaulting. In this controversial search for solutions, it is important not to slip into another extreme—de-globalization—or to erect a new “Berlin Wall” of protectionism that would separate the advanced economies from their emerging counterparts. Group 20 leaders meeting in Washington (November 2008) and London (April 2009) started the movement in the right direction by including emerging markets in the Financial Stability Forum, agreeing to provide more seats for emerging economies in the International Monetary Fund and World Bank, and increasing the role of emerging markets in the decision-making process. But this is just the beginning of a long journey toward recovery for the world economy, a journey that includes strengthening the role of the International Monetary Fund in policing financial issues, revamping financial regulation, and restoring market confidence.

Why do firms denominate bank loans in foreign currencies? Empirical evidence from Canada and U.K.

We examine the determinants of the decision to raise bank loans in foreign currency, based on two samples of syndicated loans raised by U.K. and Canadian firms. By using the percentage of sales in the U.S. market for a firm, we proxy the exposure of the firm’s cash flows to the U.S. dollar. We find strong evidence that firms which have substantial foreign sales are the ones that have a higher probability of borrowing in that foreign currency. In particular, we show that firms that have a significant portion of their sales in the U.S., will tend to hedge their exposure by borrowing in U.S. dollars. This result is consistent with the notion that foreign currency loans serve as a natural hedging instrument. Our results are also economically significant; they imply that a one standard deviation increase in the ratio of foreign sales in the U.S. increases the probability of borrowing in U.S. dollars by 23%. For the first time in the literature, we show that currency choice should be considered an integral feature of the loan contract, given interdependencies that exist between currency choice and other loan contract terms such as maturity and secured status. Our results show that maturity and secured status both affect the currency choice of the loan, however the manner in which they impact the currency choice varies between countries and is dependent on borrower characteristics.

Does adding up of economic capital for market- and credit risk amount to conservative risk assessment?

There is a tradition in the banking industry of dividing risk into market risk and credit risk. Both categories are treated independently in the calculation of risk capital. But many financial positions depend simultaneously on both market risk and credit risk factors. In this case, an approximation of the portfolio value function separating value changes into a pure market risk plus pure credit risk component can result not only in an overestimation, but also in an underestimation of risk. We discuss this compounding effect in the context of foreign currency loans and argue that a separate calculation of economic capital for market risk and for credit risk may significantly underestimate true risk.

Foreign Currency Borrowing by Small Firms

We examine the firm- and country-level determinants of the currency denomination of small business loans. We first model the choice of loan currency in a framework which features a trade-off between lower cost of debt and the risk of firm-level distress costs, and also incorporates the impact of information asymmetry between banks and firms. When foreign currency funds come at a lower interest rate, all foreign currency earners as well as those local currency earners with high revenues and low distress costs choose foreign currency loans. When the banks have imperfect information on the currency and level of firm revenues, even more local earners switch to foreign currency loans, as they do not bear the full cost of the corresponding credit risk. We then test the implications of our model by using a 2005 survey with responses from 9,098 firms in 26 transition countries. The survey contains details on 3,105 recent bank loans. At the firm level, our findings suggest that firms with foreign currency income and assets are more likely to borrow in a foreign currency. In contrast, firm-level distress costs and financial transparency affect the currency denomination only weakly. At the country level, the interest rate advantages of foreign currency funds and the exchange rate volatility do not explain the foreign currency borrowing in our sample. However, foreign bank presence, weak corporate governance and the absence of capital controls encourage foreign currency borrowing. All in all, we cannot confirm that carry-trade behavior is the key driver of foreign currency borrowing by small firms in transition economies. Our results do, however, support the conjecture that banking-sector structures and institutions that aggravate information asymmetries may facilitate foreign currency borrowing.

On the spillover of exchange rate risk into default risk

In order to reduce the exchange-rate risk, banks in emerging markets are typically denominating their loans in foreign currencies. However, in the event of a substantial depreciation of the local currency, the payment ability of a foreign-currency borrower may be reduced significantly, exposing the lender to additional default risk. This paper analyses how the exchange-rate risk of foreign currency loans spills over into default risk. We show that in an economy where foreign currency loans are a dominant source of financing economic activity, depreciation of the local currency establishes a negative feedback mechanism that leads to higher default probabilities, reduced credit supply, and reduced growth. This finding has some important implications that may be of special interest for regulators and market participants in emerging economies.

Foreign Currency Borrowing by Small Firms

We examine the firm-level and country-level determinants of the currency denomination of small business loans. We introduce an information asymmetry between banks and firms in a model that also features the trade-off between the cost of debt and firm-level distress costs. Banks in our model don’t know the currency in which firms have contracted their sales. When foreign currency funds come at a lower interest rate, all foreign currency earners and those local currency earners with low distress costs choose foreign currency loans. With imperfect information in the model concerning the currency in which the firms receive their earnings, even more local earners switch to foreign currency loans as they do not bear the full cost of the corresponding credit risk. We test these implications of our model by using a 2005 survey with responses from 9,655 firms in 26 transition countries that contains reports on 3,105 recent bank loans. We find that firms with foreign currency income and assets are more likely to borrow in foreign currency. In contrast we find only weak evidence that firm-level distress costs and financial opaqueness affect currency denomination. Interest rate advantages on foreign currency funds and exchange rate volatility partly explain differences in loan dollarization across countries, but not within countries over time. We find that country-level measures of information asymmetries (weak corporate governance and strong foreign bank presence) do encourage foreign currency borrowing, but only by foreign currency earning firms. All in all, we cannot confirm that information asymmetries and currency speculation are a key driving force of the recently observed increase in the dollarization of small business loans in Eastern European transition countries.

Balance of Payments Surplus and Renminbi Revaluation Pressure

Based on a simple theoretical exchange rate model, this paper shows how persistent balance of payments surpluses build up appreciation pressure on a fixed exchange regime in a partially-open economy such as China. A deregulated market interest rate may work as an automatic stabilizer to release some of the appreciation pressures, but it cannot fully eliminate the appreciation pressure because of the zero interest rate floor. Strategic options for the government include improving the quality of domestic assets by reducing the non-performing loans of the banking sector, so that the substitutability of domestic and foreign assets will rise and the exchange rate will be stabilized. Secondly, more foreign currency loans may be issued through the state-owned banking sector to promote economic growth and increase income while at the same time reducing the level of foreign reserves.

An empirical assessment of special accounting issues and financial attributes relating to the accounting treatment of translation gains and losses: the UK case

PurposeThis paper aims to assess the financial performance of firms that adopted or deferred the adoption of SSAP 20 “Foreign Currency Translation”. The focus of the study is to examine the impact of certain accounting issues, such as liquidity, hedging, foreign currency loans, managerial compensation, pre‐ and post SSAP 20 treatment of translation differences, etc, on the behaviour of firms.Design/methodology/approachThe paper follows the positive accounting theory context and utilises parametric (logistic regression) and non‐parametric (Kruskal–Wallis test) tests to form and test theoretical hypotheses and relations between groups of firms with different financial characteristics.FindingsThe study provides evidence that the implementation of SSAP 20 has overall strengthened the financial position of adopters. Adopters that used different translation methods prior to adoption tend to exhibit different financial characteristics (e.g. higher leverage) in the pre‐actual adoption period. In contrast, they present no substantial differences in the actual adoption period. The findings show that adopters give priority to their stock market picture and tend to distribute higher dividend to their shareholders even if this leads to lower management payout.Research limitations/implicationsFirstly, for the period under investigation, the availability of accounting and financial data and the disclosure of accounting information in the financial statements were to some extent limited. Secondly, it is difficult to see through managers’ inner intentions, and as a result managers’ behaviour and motives may not always be clear and conceivable to outsiders.Originality/valueThis study has significant implications for accounting standard setting bodies and investors. It provides insight about firms’ objectives and potential attitude and reaction to the issue of accounting regulation. This study also formulates the basis for studying firms’ behaviour and reaction with regard to other accounting standards and financial issues.

Policy strategies to deal with revaluation pressures on the renminbi

Based on a simple theoretical exchange rate model, this paper shows how persistent balance of payments surpluses build up appreciation pressure on a fixed exchange regime in a partially open economy such as China. A deregulated market interest rate may work as an automatic stabilizer to release some of the appreciation pressures, but it cannot fully eliminate the appreciation pressure because of the zero interest rate floor. Strategic options for the government include: Improving the quality of domestic assets by reducing the non-performing loans of the banking sector, so that the substitutability of domestic and foreign assets will rise and the exchange rate will be stabilized. Secondly, more foreign currency loans may be issued through the state-owned banking sector to promote economic growth and increase income while at the same time reducing the level of foreign reserves.

Liability dollarization and the bank balance sheet channel

Emerging markets' financial institutions often face a mismatch in the currency denominations of their liabilities (foreign currency-denominated debt raised from foreign lenders) and their assets (domestic currency loans to domestic borrowers). We study the effect of this mismatch on monetary policy in a sticky-price, dynamic general-equilibrium small open economy model in which the country default-risk premium depends on domestic banks' balance sheets due to asymmetric information. A fixed exchange rate rule that stabilizes bank balance sheets offers greater stability than does an interest rate rule that targets inflation to offset the real effects of sticky-prices.

Liability Dollarization and the Bank Balance Sheet Channel

Banks in developing economies often face a mismatch in the currency denomination of their liabilities (foreign currency denominated debt) and assets (domestic currency loans to domestic borrowers). We study the effect of this mismatch on business cycles and monetary policy in a sticky-price, dynamic general equilibrium model of a small open economy. We find from the model analysis that a fixed exchange rate rule that stabilizes the balance sheets of banks offers greater stability than an interest rate rule that targets inflation in the sticky-price sector of the economy.

Liability Dollarization and the Bank Balance Sheet Channel

Banks in developing economies often face a mismatch in the currency denomination of their liabilities (foreign currency denominated debt) and assets (domestic currency loans to domestic borrowers). We study the effect of this mismatch on business cycles and monetary policy in a sticky-price, dynamic general equilibrium model of a small open economy. We find from the model analysis that a fixed exchange rate rule that stabilizes the balance sheets of banks offers greater stability than an interest rate rule that targets inflation in the sticky-price sector of the economy.

THE FOREIGN CURRENCY LOANS AFFAIR: SOME COMMENTS

Kingston (1995) discusses the legal complications arising out of the foreign currency loans taken out in the middle eighties. This note discusses a number of points of difference within Kingston's interpretations. The most important example of these is the predictability of the losses arising from the loans. Some potential solutions of the problems identified by Kingston, and in this note, are also canvassed.

FXE: A bad answer to good questions

Of these three targets, the third is at the forefront of international discussions today. One solution widely discussed are the so-called Tobin tax proposals. Of the two substantive proposals, the first aims at reducing the volatility of financial markets by imposing a worldwide transactions tax. The second seeks to protect the current process of monetary unification in Europe by imposing a tax on domestic currency loans to non-residents by European banks in order to increase the cost of speculation when such loans are made (Eichengreen et al., 1995). This kind of solution is rejected, rightly in my view, by Ruben Mendez, and one could add other criticisms to those he suggests in the article (pp. 499-513). For example, neither proposal would prevent countries from experiencing exchange rate crises. If currency traders expect the possibility of large gains, the increased transaction costs would not be a sufficient deterrent. Furthermore, they would not free monetary authorities from the need to increase interest rates in case of a speculative attack, leaving unresolved the dilemma between the domestic objective of securing growth and employment and the external objective of retaining exchange rate stability. In spite of being presented as an alternative solution, FXE tells us nothing about how it could help to avoid unjustified, but self-fulfilling,

The diversification of currency loans: A comparison between safety-first and mean-variance criteria

This paper presents a model and a method for solving currency loan problems under stochastic and deterministic constraints. The currency loan problem is a mathematical programming problem, i.e., how to diversify borrower's loans in order to reduce currency and interest rate risks for the borrower. The second objective is to illustrate similarities and differences among alternative portfolio selection criteria. Applying a chance-constrained programming algorithm to the above currency loan problem we can solve it by using three different criteria, Markowitz's Mean-Variance and Safety-First criteria by Telser and Kataoka. This allows us to compare these criteria under both equality and inequality constraints.

Finnish Banks' Problem Assets: Result of Unfortunate Asset Structure of Too Rapid Growth?

The paper focuses on the proximate causes of the Finnish savings and cooperative banks' non-performing assets in the current crisis.Specifically, the effects of the lending structure at the outset of the crisis and the rate of growth of lending in the latter half of the 1980s are investigated.The main findings are: (1) Lending structure alone is not sufficient to explain the variation in the share of non-performing assets among the local banks.(2) Growth of lending is a major explanatory factor: the faster the growth in the second half of the 1980s, the higher the later share of non-performing assets.(3) Growth of lending is a particularly important cause in the case of the savings banks, where lending structure does not seem to have had much of an impact.(4) Lending to manufacturing, construction and trade has had a significant negative effect on the cooperative banks' asset quality.(5) Differences in the rate of lending growth go a long way in explaining why there are on average much more problem loans in the savings bank group than in the cooperative bank group.(6) The share of foreign currency loans is not an important factor when the effect of growth is accounted for, although the roles cannot be fully separated due to multicollinearity.(7) Assuming that growth of lending is more under the control of a bank than the structure of lending, the findings support the view that bad luck is not the only explanation of the Finnish problems but bad banking in the form of either ignorance of risks or deliberate risk taking is a major factor as well.

Policy fundamentals, interest rates differential, and expected devaluation in the presence of an active crawling peg system

One of the most interesting theoretical issues that comes up from the analysis of the tablita period in the Southern Cone economies—Argentina, Chile and Uruguay—is the interpretation of why interest rates on domestic currency loans were much higher than the rate on foreign currency loans adjusted for devaluation of the domestic currency, even though the rate of devaluation was set by the monetary authorities six months ahead and published in a little table ( tablita). This was particularly puzzling in the case of Uruguay which had practically perfect capital mobility. We show that the reason rational economic agents were willing to pay high domestic interest rates rather than borrowing in foreign currency was that they realized that policy fundamentals were inconsistent with the sustainability of the exchange rate policy. Using data for Uruguay we show that a second systematic component of expectations of devaluation is what we call ‘the policy risk factor’ and modeled as a function of the fiscal and monetary variables. (JEL 41, 31).