A New Index of Currency Mismatch and Systemic Risk

IMF Working Papers, November 1, 2010

Source details

Authors: Romain Ranciere, Aaron Tornell, Athanasios Vamvakidis
Publication date: November 1, 2010
Objective: Construct a new measure of currency mismatch in the banking sector that controls for bank lending to unhedged borrowers and captures indirect exchange rate risk not visible in balance-sheet-only indicators.
Scope: Constructed for 10 emerging European economies and for a broader sample that includes 19 additional emerging economies, for the period 1998 - 2008.
Motivation: Existing indicators based only on banks’ balance sheet data miss systemic risk arising when banks lend to borrowers unable to repay after a sharp depreciation.

The new measure:
- Controls for bank lending to unhedged borrowers.
- Explicitly accounts for indirect exchange rate risk that banks undertake via their borrowers.
Comparative approach:
- Compares the new measure with previous currency mismatch measures that do not adjust for unhedged foreign currency borrowing to illustrate advantages.

The new index flagged indirect currency mismatch vulnerabilities that were building up in a number of emerging economies before the recent global crisis.
Indicators based solely on banks’ balance sheet data can fail to capture systemic risk arising from unhedged foreign currency borrowing.
More accurate measurement of currency mismatch can help authorities address vulnerabilities earlier and avoid measures that would hurt growth prospects.

Measure currency mismatch more accurately by including banks’ exposure through lending to unhedged borrowers.
Use the enhanced measure to:
- Detect building systemic vulnerabilities earlier.
- Inform timely policy responses that minimize negative impacts on growth prospects.