## 1. De-dollarization 200110

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---

### Introduction
- Financial dollarization: large share of residents’ assets and liabilities denominated in U.S. dollars; prevalent in many Latin American banking systems.
- Typical origin: past episodes of severe economic crisis and high inflation that made the U.S. dollar the preferred currency.
- Persistence puzzle: dollarization ratios of deposits and loans often remain high after inflation falls and macroeconomic stability is restored.
- Market-friendly successful de-dollarization examples cited: Bolivia, Paraguay, Peru, and Uruguay.

### Main empirical findings
- Drivers of deposit de-dollarization are different from those of credit de-dollarization.
- The appreciation trends experienced during the last decade have been key for deposit de-dollarization in these countries.
- An active management of reserve requirement differentials has contributed to credit de-dollarization.
- The introduction of other prudential measures to create incentives to internalize the risks of dollarization (such as higher provision requirements for foreign currency loans, and tighter limits on the banks’ net open position) has also fostered credit de-dollarization.
- The extension of the domestic currency yield curve has facilitated credit de-dollarization.
- De-dollarization of deposits has also contributed to credit de-dollarization.

### Stylized facts — trend and key statistics
- Deposit dollarization declined (on average) by 27 percentage points between 2001:Q1 and 2010:Q3 (Table 1).
- Cross-country changes in deposit dollarization 2001:Q1–2010:Q3 (in percent):
  - Bolivia: -41.8
  - Paraguay: -26.1
  - Peru: -28.7
  - Uruguay: -10.4
  - Average: -26.8
- Cross-country changes in credit dollarization 2001:Q1–2010:Q3 (in percent):
  - Bolivia: -40.7
  - Paraguay: -14.7
  - Peru: -26.8
  - Uruguay: -22.6
  - Average: -26.2
- Deposit and credit dollarization computed with foreign currency positions evaluated at a constant exchange rate.
- Dollarization is higher for less liquid deposits; declines in deposit dollarization occurred within maturities (sight, saving, time) rather than only via compositional shifts.
- Credit dollarization is higher for loans with longer maturities (mortgages and commercial credit); de-dollarization of credit was driven mainly by within-sector declines rather than compositional shifts.

### Empirical approach and model specification
- Model: country-specific unrestricted VAR.
- Variables included:
  - Macro-variables:
    - inflation_t: Sum over t and t-1 of the monthly percentage change of the CPI
    - e_t: Sum over t and t-1 of the monthly percentage change of the nominal exchange rate
    - s_t: Standard deviation of daily percentage change of the nominal exchange rate over 90-days
    - Δembi_t: First-difference of the EMBI spread, divided by 100
  - Prudential measures:
    - ΔRR_t: Difference over t and t-2 of the spread between the required RR rate on foreign currency deposits to the rate on domestic currency deposits (in percent)
    - d_t: Dummy equal to 1 (for three months) after the introduction of prudential measures (other than changes in reserve requirements); zero otherwise
  - Development of domestic capital market:
    - d_{3010−t}: Dummy equal to 1 if medium-to-long term bonds (between 10 to 30 years, depending of the country) were issued in that month; zero otherwise.
  - Financial dollarization:
    - ΔDL_t: Change over t and t-1 of the deposit dollarization ratio
    - ΔCL_t: Change over t and t-1 of the credit dollarization ratio
- Note: Deposit and credit dollarization are computed at constant exchange rate. In Peru, dollarization ratios use December 2008 weights to avoid composition effects.
- Identification: Choleski decomposition with ordering:
  1. introduction of prudential measures in the financial sector;
  2. extension of the yield curve for public bonds in local currency;
  3. macro-variables;
  4. change in deposit dollarization;
  5. change in credit dollarization.
- Estimation details:
  - Lags: three lags in baseline specification (six lags in alternative specification for robustness).
  - Sample period: monthly data from January 2001 through September 2010 (starting in 2003 for Bolivia and 2004 for Uruguay to exclude crises).

### Role of macro variables: exchange rate trend and volatility
- De-dollarization coincided with macroeconomic stabilization: low inflation, anchored inflation expectations, gradual appreciation of currencies.
- Empirical focus: test whether months with larger appreciation moves led to faster declines in deposit dollarization.
- Exchange rate variables included in VAR: cumulative monthly changes (e_t) and 90-day exchange rate volatility (s_t).
- As dollarization rates declined and preconditions of macro-stability were in place, monetary authorities appear to have had a greater tolerance for exchange rate volatility in some countries.
- Evidence in the literature on the link between exchange rate volatility and dollarization is mixed.

### Decomposition analysis — Peru (selected sectoral and maturity results)
- Method: changes in credit and deposit dollarization decomposed into “within” and “between” components (García‐Escribano, 2010 methodology).
- Credit dollarization — sectoral total change and decomposition (in percent):
  - Commercial: 2001 80.8 → 2010 66.4; total effect -21.9 (between effect -10.5, within effect -11.4)
  - Small business: 2001 50.3 → 2010 14.4; total effect -35.9 (between effect 2.6, within effect -6.0, net -0.4)
  - Consumer: 2001 47.8 → 2010 14.0; total effect -33.8 (between effect 9.0, within effect 17.0, net -1.9)
  - Mortgage: 2001 94.1 → 2010 55.8; total effect -38.3 (between effect 9.4, within effect 13.9, net -1.1)
  - Total credit: 2001 78.3 → 2010 52.9; total effect -25.4 (between effect -6.4, within effect -18.9)
- Deposit dollarization — maturity decomposition (in percent):
  - Sight: 2001 58.7 → 2010 48.4; total effect -10.3 (between effect 5.3, within effect -2.0, net 3.4)
  - Saving: 2001 71.7 → 2010 45.7; total effect -26.0 (between effect -2.4, within effect -8.3, net -10.8)
  - Time: 2001 84.6 → 2010 50.8; total effect -33.8 (between effect -2.9, within effect -16.5, net -19.4)
  - Total deposits: 2001 75.5 → 2010 48.7; total effect -26.8 (between effect 0.0, within effect -26.8)

### Policy-relevant mechanisms emphasized
- Exchange rate appreciation reduced deposit dollarization (trend-driven).
- Reserve requirement differentials (ΔRR_t) as an active policy tool contributed to reducing credit dollarization.
- Prudential dummies (d_t) capturing measures like higher provisioning for FX loans and tighter net open position limits contributed to credit de-dollarization.
- Issuance of medium-to-long term local currency bonds (d_{3010−t}) extended the domestic yield curve and facilitated credit de-dollarization by improving banks’ ability to fund and price long-term domestic currency loans.
- Deposit de-dollarization preceded and helped drive credit de-dollarization.

### The introduction of prudential measures and reserve requirements (selected country actions)
- Bolivia introduced a financial transaction tax on foreign currency debits and credits, while exempting transactions in Bolivianos (mid-2006).
- Bolivia raised the marginal cash reserve requirement for deposits in foreign currency to 30 percent (measure effective in January 2009).
- Bolivia established in June 2009 that the marginal reserve requirement in domestic currency could be reduced by an amount equivalent to the increase in domestic currency credit relative to the stock of June 30, 2009—up to the equivalent of 100 percent of the cash reserve requirement (2 percent) and 40 percent of the reserve requirement in securities (10 percent). Hence, the reserve requirements associated to deposits in Bolivianos and UFV could decline by half in practice (from 12 percent of deposits to 6 percent).
- Since early-2009, Bolivian banks required to constitute an additional provision of up to 1.5 percent for foreign currency denominated loans classified as “A”.
- Since mid-2006, Peruvian banks must carry out a routine evaluation of currency risks or set up an additional reserve ranging from 0.25 to 1 percent for credit in foreign currency not evaluated.
- Limits on banks’ long open positions adjusted over time in several countries (examples: Bolivia reduced limit to 60 percent from 70 percent in late 2009; Paraguay net open position limit 50 percent of capital in mid-2007 and reduced long position to 30 percent in late-2008; Peru changed long (short) open position to 75 (15) percent of capital in early-2010 from 100 (10) percent; Uruguay set net open position limit of 150 percent of minimum required regulatory capital in late-2003).
- Uruguay required differentiated capital risk weights on foreign currency loans since mid- (text truncated in source).

### Capital market development in local currency
- Credit de-dollarization facilitated by development of local-currency capital markets, especially issuance of long-term public bonds.
- Maturities and yield curve extensions:
  - Longest maturity of fixed-rate government paper in domestic currency in Peru is 32 years (while it was 5 years in 2003).
  - The inflation-adjusted “VAC” curve extends up to 39-year tenors but represents only 10 percent of domestic public bonds in Peru.
  - Yield curve extends up to 30 years in Bolivia and 15 years in Uruguay.
  - Paraguay had not started issuing long-term public debt in local currency during the period analyzed.

### Empirical results (VAR: impulse responses and variance decomposition)
- Impulse response key findings:
  - Increasing the ratio of foreign-to-local currency reserve requirement rates helped foster:
    - credit de-dollarization in Paraguay and Peru;
    - deposit de-dollarization in Bolivia and Paraguay.
  - Timing: effects are quite rapid, with significance only one month after the shock.
  - Prudential measures internalizing currency risk tended to help credit de-dollarization in Bolivia, Paraguay, and Uruguay, with effects on impact lasting up to two months; effects on deposit dollarization were not statistically significant.
  - Issuance of local-currency long-term public bonds contributed to credit de-dollarization in Bolivia, Peru, and Uruguay; effect on deposit de-dollarization was not significant.
  - Exchange rate appreciation trend contributed to deposit de-dollarization in Bolivia, Peru, and Uruguay; impact is rapid and significant. In Bolivia, exchange rate appreciation also played a role in credit de-dollarization; no such effects found for Paraguay, Peru, and Uruguay on credit (except Bolivia).
  - Exchange rate volatility effects:
    - Shocks to exchange rate volatility contributed to credit de-dollarization in Peru.
    - Volatility shocks helped deposit de-dollarization in Paraguay (results not strongly significant).
    - In Uruguay, exchange rate volatility did not appear to contribute to de-dollarization.
    - In Bolivia, exchange rate volatility shocks had a positive impact on both deposit and credit de-dollarization; interpreted as reflecting larger appreciation changes under a crawling peg rather than two-way volatility.
  - Causality direction: changes in deposit dollarization cause changes in credit dollarization. Changes in deposit dollarization have a strong impact on credit dollarization in the same direction in all countries analyzed.
- Size of one standard deviation shocks (Table 4):
  - ER changes:
    - Bolivia 0.21
    - Paraguay 2.56
    - Peru 1.31
    - Uruguay 2.06
  - ER volatility:
    - Bolivia 0.01
    - Paraguay 0.14
    - Peru 0.08
    - Uruguay 0.16
- Variance decomposition — average contributions (horizon six months):
  - Changes in prudential regulation (including reserve requirement ratios) explain about 7 percent of credit dollarization variations.
  - Contribution of shocks to development of local currency public bonds market is about 11 percent on average to credit dollarization.
  - Changes in deposit dollarization account for about 8 percent of credit dollarization fluctuations.
  - For deposits, exchange rate movements explain around 8 percent of dollarization variations.
- Robustness checks:
  - Results robust to extending lag length to 6 months; alternative Choleski orderings; redefining dollarization ratios using current exchange rates; in Uruguay, using resident-only deposit dollarization.

### Summary of drivers
- Main patterns:
  - Forces driving deposit de-dollarization differ from those driving credit de-dollarization.
  - Credit de-dollarization drivers:
    - Active management of reserve requirements.
    - Introduction of prudential measures to internalize currency risk.
    - Development of local-currency capital markets (extension of public bond yield curve).
    - De-dollarization of deposits (banks’ matching behavior) also contributes to credit de-dollarization.
  - Deposit de-dollarization drivers:
    - Exchange rate appreciation trend observed during the period.
  - Changes in other macro variables (inflation rates, EMBI spreads) do not appear to have short-term impact on financial de-dollarization, though macroeconomic stability remains a pre-condition.

### Policy implications and concluding remarks
- Despite a steady decline, dollarization levels remain high in Bolivia, Paraguay, Peru, and Uruguay; continued efforts are needed.
- Key policy implications:
  - Maintain strong fundamentals and macroeconomic stability (for instance, keeping a low and stable inflation).
  - Ensure prudential regulation (including active management of reserve requirements) provides incentives for appropriate internalization of currency risks by agents.
  - Further develop local currency capital markets (deepen local currency markets for public and private bonds) to enhance de-dollarization.

*Source: _wp1110 - 1. De-dollarization 200110 (IMF PDF).*

### 1. De-dollarization 200110 .............................................................................................

### 1. De-dollarization 200110

### Introduction
- Financial dollarization: large share of residents’ assets and liabilities denominated in U.S. dollars; prevalent in many Latin American banking systems.
- Typical origin: past episodes of severe economic crisis and high inflation that made the U.S. dollar the preferred currency.
- Persistence puzzle: dollarization ratios of deposits and loans often remain high after inflation falls and macroeconomic stability is restored.
- Market-friendly successful de-dollarization examples cited: Bolivia, Paraguay, Peru, and Uruguay.

### Main empirical findings (as stated in the chapter)
- Drivers of deposit de-dollarization are different from those of credit de-dollarization.
- The appreciation trends experienced during the last decade have been key for deposit de-dollarization in these countries.
- An active management of reserve requirement differentials has contributed to credit de-dollarization.
- The introduction of other prudential measures to create incentives to internalize the risks of dollarization (such as higher provision requirements for foreign currency loans, and tighter limits on the banks’ net open position) has also fostered credit de-dollarization.
- The extension of the domestic currency yield curve has facilitated credit de-dollarization.
- De-dollarization of deposits has also contributed to credit de-dollarization.

### De-dollarization trend — stylized facts (selected quantitative highlights)
- Deposit dollarization declined (on average) by 27 percentage points between 2001:Q1 and 2010:Q3 (Table 1).
- Cross-country changes in deposit dollarization 2001:Q1–2010:Q3 (in percent):
  - Bolivia: -41.8
  - Paraguay: -26.1
  - Peru: -28.7
  - Uruguay: -10.4
  - Average: -26.8
- Cross-country changes in credit dollarization 2001:Q1–2010:Q3 (in percent):
  - Bolivia: -40.7
  - Paraguay: -14.7
  - Peru: -26.8
  - Uruguay: -22.6
  - Average: -26.2
- Deposit and credit dollarization computed with foreign currency positions evaluated at a constant exchange rate.
- Dollarization is higher for less liquid deposits; declines in deposit dollarization occurred within maturities (sight, saving, time) rather than only via compositional shifts.
- Credit dollarization is higher for loans with longer maturities (mortgages and commercial credit); de-dollarization of credit was driven mainly by within-sector declines rather than compositional shifts.

### Empirical approach and model specification
- Model: country-specific unrestricted VAR.
- Variables included (groups and exact variable definitions as in Table 3):
  - Macro-variables:
    - inflation_t: Sum over t and t-1 of the monthly percentage change of the CPI
    - e_t: Sum over t and t-1 of the monthly percentage change of the nominal exchange rate
    - s_t: Standard deviation of daily percentage change of the nominal exchange rate over 90-days
    - Δembi_t: First-difference of the EMBI spread, divided by 100
  - Prudential measures:
    - ΔRR_t: Difference over t and t-2 of the spread between the required RR rate on foreign currency deposits to the rate on domestic currency deposits (in percent)
    - d_t: Dummy equal to 1 (for three months) after the introduction of prudential measures (other than changes in reserve requirements); zero otherwise
  - Development of domestic capital market:
    - d_{3010−t}: Dummy equal to 1 if medium-to-long term bonds (between 10 to 30 years, depending of the country) were issued in that month; zero otherwise.
  - Financial dollarization:
    - ΔDL_t: Change over t and t-1 of the deposit dollarization ratio
    - ΔCL_t: Change over t and t-1 of the credit dollarization ratio
- Note: Deposit and credit dollarization are computed at constant exchange rate. In Peru, dollarization ratios use December 2008 weights to avoid composition effects.
- Identification: Choleski decomposition with ordering:
  1. introduction of prudential measures in the financial sector;
  2. extension of the yield curve for public bonds in local currency;
  3. macro-variables;
  4. change in deposit dollarization;
  5. change in credit dollarization.
- Estimation details:
  - Lags: three lags in baseline specification (six lags in alternative specification for robustness).
  - Sample period: monthly data from January 2001 through September 2010 (starting in 2003 for Bolivia and 2004 for Uruguay to exclude crises).

### Role of macro variables: exchange rate trend and volatility
- De-dollarization coincided with macroeconomic stabilization: low inflation, anchored inflation expectations, gradual appreciation of currencies.
- Empirical focus: test whether months with larger appreciation moves led to faster declines in deposit dollarization.
- Exchange rate variables included in VAR: cumulative monthly changes (e_t) and 90-day exchange rate volatility (s_t).

### Decomposition analysis (Peru example)
- Changes in credit and deposit dollarization decomposed into “within” and “between” components (García‐Escribano, 2010 methodology).
- Peru 2001–2010 decompositions (selected sectoral results for credit; maturities for deposits):
  - Credit dollarization — sectoral total change and decomposition (in percent):
    - Commercial: 2001 80.8 → 2010 66.4; total effect -21.9 (between effect -10.5, within effect -11.4)
    - Small business: 2001 50.3 → 2010 14.4; total effect -35.9 (between effect 2.6, within effect -6.0, net -0.4) [table shows small business entries; preserve original formatting: shows small business 50.3 14.4 2.6 6.0 0.5 -0.9 -0.4]
    - Consumer: 2001 47.8 → 2010 14.0; total effect -33.8 (between effect 9.0, within effect 17.0, net -1.9) [table entries: consumer 47.8 14.0 9.0 17.0 1.1 -3.0 -1.9]
    - Mortgage: 2001 94.1 → 2010 55.8; total effect -38.3 (between effect 9.4, within effect 13.9, net -1.1) [mortgage 94.1 55.8 9.4 13.9 2.5 -3.6 -1.1]
    - Total credit: 2001 78.3 → 2010 52.9; total effect -25.4 (between effect -6.4, within effect -18.9)
  - Deposit dollarization — maturity decomposition (in percent):
    - Sight: 2001 58.7 → 2010 48.4; total effect -10.3 (between effect 5.3, within effect -2.0, net 3.4)
    - Saving: 2001 71.7 → 2010 45.7; total effect -26.0 (between effect -2.4, within effect -8.3, net -10.8)
    - Time: 2001 84.6 → 2010 50.8; total effect -33.8 (between effect -2.9, within effect -16.5, net -19.4)
    - Total deposits: 2001 75.5 → 2010 48.7; total effect -26.8 (between effect 0.0, within effect -26.8)

### Policy-relevant mechanisms emphasized
- Exchange rate appreciation reduced deposit dollarization (trend-driven).
- Reserve requirement differentials (ΔRR_t) as an active policy tool contributed to reducing credit dollarization.
- Prudential dummies (d_t) capturing measures like higher provisioning for FX loans and tighter net open position limits contributed to credit de-dollarization.
- Issuance of medium-to-long term local currency bonds (d_{3010−t}) extended the domestic yield curve and facilitated credit de-dollarization by improving banks’ ability to fund and price long-term domestic currency loans.
- Deposit de-dollarization preceded and helped drive credit de-dollarization.

*Source: _wp1110 - 1. De-dollarization 200110 (IMF PDF).*

### 2010. Data for Uruguay starts  in January 2004.

### _wp1110 - 2010. Data for Uruguay starts in January 2004.

### Exchange rate volatility and dollarization
- As dollarization rates declined (and hence, vulnerabilities associated to financial dollarization were contained) and preconditions of macro-stability were in place, monetary authorities seem to have had a greater tolerance for exchange rate volatility in some of these countries.
- A strand of the literature looks at the opposite direction of causality, suggesting that financial dollarization is influenced by exchange rate volatility. However, the evidence on this relationship is mixed.

### Evidence from the literature (selected findings cited)
- Kokenyne et al. (2010): “two-way” exchange rate volatility fosters de-dollarization by rendering foreign exchange risk more apparent.
- Barajas and Morales (2003): greater exchange rate volatility reduces credit dollarization in a sample of Latin American countries.
- García-Escribano (2010) and Luca and Petrova (2007): similar results for Peru and a sample of transition economies respectively.
- Berkmen and Cavallo (2010), Rennhack and Nozaki (2006), and Neanidis and Savva (2009): do not find evidence that a more flexible exchange rate regime, by itself, promotes de-dollarization.
- Arteta (2005): more flexibility is actually associated with higher dollarization, especially in the case of deposits.

### Empirical observations (Figure 8 and associated notes)
- Figure 8 shows that higher exchange rate volatility associated with an appreciation trend has been accompanied by a fall in dollarization in the case of credit in Bolivia and Peru, and deposits in Bolivia.
- Axis and data labels appearing in the figure (preserved exactly as in source):
  - 6
  - 6.5
  - 7
  - 7.5
  - 8
  - 8.5
  - 9
  - 0
  - 10
  - 20
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  - 60
  - 70
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  - credit dollarization
  - deposit dollarization
  - exchange rate (domestic currency/US $)
  - 2003
  - 2004200620082010
  - 0
  - 1000
  - 2000
  - 3000
  - 4000
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  - 2003
  - 2004200620082010
  - 2.5
  - 3
  - 3.5
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  - 4.5
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  - 20
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  - 2004200620082010
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  - 2004200620082010
  - b.
  - a.
  - c.
  - d.
  - -1
  - -0.8
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  - -0.4
  - -0.2
  - 0
  - 0.2
  - 0.4
  - 0.6
  - 0.8
  - 1
  - 00.20.40.60.8
  - Peru credit dollarization
  - Bolivia credit dollarization
  - Bolivia deposit dollarization
  - Monthly standard deviation of daily percentage change of nominal 
    exchnage rate over 
    past90-days
  - Do llarization rate (percent), monthly change

### The introduction of prudential measures
- During the past decade, Bolivia, Paraguay, Peru and Uruguay introduced different prudential measures to lower banks’ incentives to borrow and lend in foreign currency, as well as to diminish agents’ preferences for using foreign currency as a means of payments.
- Source annotation repeated in figure notes: IMF staff calculations; 1/ Foreign currency credit and deposits evaluated at constant exchange rate.

### Country-specific prudential actions (as stated)
- Bolivia and Peru have raised provisions for foreign currency loans.
- Bolivia, Paraguay, Peru and Uruguay have tightened capital requirements against open foreign exchange positions.
- Uruguay required differentiated capital risk weights on foreign currency loans since mid-

*Source: IMF staff calculations. 1/ Foreign currency credit and deposits evaluated at constant exchange rate.*

### 2006. Bolivia introduced a financial transaction tax on foreign currency debits and credits,

### _wp1110 - 2006. Bolivia introduced a financial transaction tax on foreign currency debits and credits,

### Prudential measures and reserve requirements
- Bolivia introduced a financial transaction tax on foreign currency debits and credits, while exempting transactions in Bolivianos (mid-2006).
- Active management of reserve requirements used as a tool to foster de-dollarization:
  - Bolivia raised the marginal cash reserve requirement for deposits in foreign currency to 30 percent (measure effective in January 2009).
  - Bolivia established in June 2009 that the marginal reserve requirement in domestic currency could be reduced by an amount equivalent to the increase in domestic currency credit relative to the stock of June 30, 2009—up to the equivalent of 100 percent of the cash reserve requirement (2 percent) and 40 percent of the reserve requirement in securities (10 percent). Hence, the reserve requirements associated to deposits in Bolivianos and UFV could decline by half in practice (from 12 percent of deposits to 6 percent).
- Other prudential measures (examples and timing):
  - Since early-2009, Bolivian banks required to constitute an additional provision of up to 1.5 percent for foreign currency denominated loans classified as “A”.
  - Since mid-2006, Peruvian banks must carry out a routine evaluation of currency risks or set up an additional reserve ranging from 0.25 to 1 percent for credit in foreign currency not evaluated.
  - Limits on banks’ long open positions adjusted over time in several countries (examples: Bolivia reduced limit to 60 percent from 70 percent in late 2009; Paraguay net open position limit 50 percent of capital in mid-2007 and reduced long position to 30 percent in late-2008; Peru changed long (short) open position to 75 (15) percent of capital in early-2010 from 100 (10) percent; Uruguay set net open position limit of 150 percent of minimum required regulatory capital in late-2003).

### Capital market development in local currency
- Credit de-dollarization facilitated by development of local-currency capital markets, especially issuance of long-term public bonds.
- Maturities and yield curve extensions:
  - Longest maturity of fixed-rate government paper in domestic currency in Peru is 32 years (while it was 5 years in 2003).
  - The inflation-adjusted “VAC” curve extends up to 39-year tenors but represents only 10 percent of domestic public bonds in Peru.
  - Yield curve extends up to 30 years in Bolivia and 15 years in Uruguay.
- Paraguay had not started issuing long-term public debt in local currency during the period analyzed.

### Empirical results (VAR analysis: impulse responses and variance decomposition)
- Methodology:
  - Impulse response functions shown at each month (not cumulative).
  - Variance decomposition quantifies relative importance of shocks.
- Key empirical findings from impulse responses:
  - Increasing the ratio of foreign-to-local currency reserve requirement rates helped foster:
    - credit de-dollarization in Paraguay and Peru;
    - deposit de-dollarization in Bolivia and Paraguay.
  - Timing: effects are quite rapid, with significance only one month after the shock.
  - Prudential measures internalizing currency risk (raising provisions, differentiated capital risk weights, tightening capital for open FX positions) tended to help credit de-dollarization in Bolivia, Paraguay, and Uruguay, with effects on impact lasting up to two months; effects on deposit dollarization were not statistically significant.
  - Issuance of local-currency long-term public bonds contributed to credit de-dollarization in Bolivia, Peru, and Uruguay; effect on deposit de-dollarization was not significant.
  - Exchange rate appreciation trend contributed to deposit de-dollarization in Bolivia, Peru, and Uruguay; impact is rapid and significant. In Bolivia, exchange rate appreciation also played a role in credit de-dollarization; no such effects found for Paraguay, Peru, and Uruguay on credit (except Bolivia).
  - Exchange rate volatility effects:
    - Shocks to exchange rate volatility contributed to credit de-dollarization in Peru.
    - Volatility shocks helped deposit de-dollarization in Paraguay (results not strongly significant).
    - In Uruguay, exchange rate volatility did not appear to contribute to de-dollarization.
    - In Bolivia, exchange rate volatility shocks had a positive impact on both deposit and credit de-dollarization; interpreted as reflecting larger appreciation changes under a crawling peg rather than two-way volatility.
  - Causality direction: changes in deposit dollarization cause changes in credit dollarization. Changes in deposit dollarization have a strong impact on credit dollarization in the same direction in all countries analyzed, reflecting banks’ behavior of maintaining matched foreign currency positions.

### Size of shocks (Table 4)
- Size of one standard deviation shocks:
  - ER changes:
    - Bolivia 0.21
    - Paraguay 2.56
    - Peru 1.31
    - Uruguay 2.06
  - ER volatility:
    - Bolivia 0.01
    - Paraguay 0.14
    - Peru 0.08
    - Uruguay 0.16

### Variance decomposition and contributions to dollarization variations
- Average contributions (summary):
  - Changes in prudential regulation (including reserve requirement ratios) explain about 7 percent of credit dollarization variations (for a horizon of six months).
  - Contribution of shocks to development of local currency public bonds market is about 11 percent on average to credit dollarization.
  - Changes in deposit dollarization account for about 8 percent of credit dollarization fluctuations.
  - For deposits, exchange rate movements explain around 8 percent of dollarization variations.
- Robustness checks:
  - Results robust to: extending lag length to 6 months; alternative Choleski orderings; redefining dollarization ratios using current exchange rates; in Uruguay, using resident-only deposit dollarization. Results do not differ significantly from baseline.

### Summary of drivers (Table 7 — impulse response summary)
- Main patterns:
  - Forces driving deposit de-dollarization differ from those driving credit de-dollarization.
  - Credit de-dollarization drivers:
    - Active management of reserve requirements.
    - Introduction of prudential measures to internalize currency risk.
    - Development of local-currency capital markets (extension of public bond yield curve).
    - De-dollarization of deposits (banks’ matching behavior) also contributes to credit de-dollarization.
  - Deposit de-dollarization drivers:
    - Exchange rate appreciation trend observed during the period.
  - Changes in other macro variables (inflation rates, EMBI spreads) do not appear to have short-term impact on financial de-dollarization, though macroeconomic stability remains a pre-condition.

### Policy implications and concluding remarks
- Despite a steady decline, dollarization levels remain high in Bolivia, Paraguay, Peru, and Uruguay; continued efforts are needed.
- Key policy implications:
  - Maintain strong fundamentals and macroeconomic stability (for instance, keeping a low and stable inflation).
  - Ensure prudential regulation (including active management of reserve requirements) provides incentives for appropriate internalization of currency risks by agents.
  - Further develop local currency capital markets (deepen local currency markets for public and private bonds) to enhance de-dollarization.

*Source: IMF staff calculations and analysis in the referenced document.*

### References

### _wp1110 - References

### References

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- Arteta, C., “Exchange Rate Regimes and Financial Dollarization: Does Flexibility Reduce Bank Currency Mismatches?,” Berkeley Electronic Journals in Macroeconomics, Topics in Macroeconomics 5 (2005): Article 10.
- Banco Central Reserva de Peru, 2005, “Fenómeno de la Dolarización,” in Reporte de Inflación, May, pp. 42−46.
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*Source: _wp1110 - References*

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