Central Banks as Dollar Lenders of Last Resort: Implications for Regulation and Reserve Holdings

Mitali Das, Gita Gopinath, Taehoon Kim and Jeremy C. Stein

No 2023/008, IMF Working Papers from International Monetary Fund

Abstract: This paper explores how non-U.S. central banks behave when firms in their economies engage in currency mismatch, borrowing more heavily in dollars than justified by their operating exposures. We begin by documenting that, in a panel of 53 countries, central bank holdings of dollar reserves are significantly correlated with the dollar-denominated bank borrowing of their non-financial corporate sectors, controlling for a number of known covariates of reserve accumulation. We then build a model in which the central bank can deal with private-sector mismatch, and the associated risk of a domestic financial crisis, in two ways: (i) by imposing ex ante financial regulations such as bank capital requirements; or (ii) by building a stockpile of dollar reserves that allow it to serve as an ex post dollar lender of last resort. The model highlights a novel externality: individual central banks may tend to over-accumulate dollar reserves, relative to what a global planner would choose. This is because individual central banks do not internalize that their hoarding of reserves exacerbates a global scarcity of dollar-denominated safe assets, which lowers dollar interest rates and encourages firms to increase the currency mismatch of their liabilities. Relative to the decentralized outcome, a global planner may prefer stricter financial regulation (e.g., higher bank capital requirements) and reduced holdings of dollar reserves.

Keywords: Foreign reserves; central banks; currency mismatch; lender of last resort; financial regulation; dollar reserve; bank borrowing; post dollar lender of last resort; dollar interest rates; reserve holding; International reserves; Banking crises; Currency mismatches; Reserves accumulation; Exchange rates; Global (search for similar items in EconPapers)
Pages: 61
Date: 2023-01-18
New Economics Papers: this item is included in nep-ban, nep-ifn, nep-mon and nep-opm
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