Foreign Exchange Intervention and the Banking System Balance Sheet in Emerging Market Economies

34 Pages Posted: 29 Apr 2014

See all articles by Blaise Gadanecz

Blaise Gadanecz

Bank for International Settlements - Monetary and Economic Department

Aaron N. Mehrotra

Bank for International Settlements (BIS)

Madhusudan S. Mohanty

Bank for International Settlements (BIS) - Monetary and Economic Department

Abstract

Large-scale forex intervention in emerging market economies (EMEs) aimed at resisting currency appreciation has major implications for the composition of banking system balance sheets. The domestic monetary consequences depend on the nature of central bank liabilities that are the counterpart of forex reserves. Even if the immediate change in bank reserves due to FX intervention is offset by the sale of securities, bank lending may still be stimulated, running counter to the aims of the monetary authority. In this paper, we empirically investigate the impact of banks' holdings of liquid government securities, generated by such intervention, on bank credit in a panel of EMEs. We find that, for well capitalised banking systems, holdings of government and central bank paper over time lead to an expansion in their credit to the private sector. This result is confirmed at both country and bank level. The balance sheet effects of large-scale FX intervention therefore require close attention.

Keywords: bank lending, sterilised intervention, foreign exchange reserves, central bank securities, emerging market economies

JEL Classification: E51, E52, E58, F31

Suggested Citation

Gadanecz, Blaise and Mehrotra, Aaron N. and Mohanty, Madhusudan S., Foreign Exchange Intervention and the Banking System Balance Sheet in Emerging Market Economies. BIS Working Paper No. 445, Available at SSRN: https://ssrn.com/abstract=2428107

Blaise Gadanecz (Contact Author)

Bank for International Settlements - Monetary and Economic Department ( email )

Centralbahnplatz 2
CH-4002 Basel
Switzerland
+41 61 280 8417 (Phone)
+41 61 280 8100 (Fax)

Aaron N. Mehrotra

Bank for International Settlements (BIS) ( email )

Centralbahnplatz 2
Basel, Basel-Stadt 4002
Switzerland

Madhusudan S. Mohanty

Bank for International Settlements (BIS) - Monetary and Economic Department ( email )

Centralbahnplatz 2
CH-4002 Basel
Switzerland

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