Managing Capital Flows and Exchange Rates
KDI/EWC series on Economic Policy
Edited by Dongsoo Kang and Andrew Mason
Chapter 8: Foreign currency liquidity risk and prudential regulation of banks
In open emerging economies, commercial banks carry substantial amounts of foreign currency assets and liabilities, and unexpected difficulties in refinancing foreign liabilities often lead to systemic banking crises. It is therefore a crucial policy task to strengthen the risk management capacity of banks and establish an effective prudential regulatory framework to better monitor and contain foreign currency liquidity risk. By engaging in foreign currency financial intermediation, banks in open emerging economies are exposed to greater liquidity risk than local currency banking, to risks of foreign currency liquidity and systemwide banking crises and to greater asymmetric information problems that may result in bank runs. Moreover, the local central bank’s lender-of-last-resort role in foreign currency is substantially limited regardless of the size of its international reserves.
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