Macroprudential Regulation of International Finance
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Macroprudential Regulation of International Finance

Managing Capital Flows and Exchange Rates

Edited by Dongsoo Kang and Andrew Mason

Recent events, such as capital flow reversals and banking sector crises, have shaken faith in the widely held belief in the benefits of greater financial integration and financial deepening, which are typical in advanced economies. This book shows that emerging economies have often weathered the storm best despite the supposed burden of ‘weak institutions’. It demonstrates that a better policy framework requires reliable indicators of vulnerability to financial instability, as well as improved policy tools and automatic stabilizers that anticipate and limit the vulnerabilities to financial crises.
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Chapter 8: Foreign currency liquidity risk and prudential regulation of banks

Sungbin Cho and Joon-Ho Hahm


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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