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

CentralBanksasDollarLendersofLastResort: ImplicationsforRegulationandReserveHoldings MitaliDas,GitaGopinath,TaehoonKim,andJeremyC.SteinWP/23/8 IMFWorkingPapersdescriberesearchinprogressbytheauthor(s)andarepublishedtoelicitcommentsandtoencouragedebate. TheviewsexpressedinIMFWorkingPapersarethoseoftheauthor(s)anddonotnecessarilyrepresenttheviewsoftheIMF,itsExecutiveBoard,orIMFmanagement. 2023 JAN ©2023InternationalMonetaryFundWP/23/8 IMFWorkingPaper OfficeoftheManagementDirector CentralBanksasDollarLendersofLastResort:ImplicationsforRegulationandReserveHoldingsPreparedbyMitaliDas,GitaGopinath,TaehoonKim,andJeremyC.Stein* AuthorizedfordistributionbyGerryRice January2023 IMFWorkingPapersdescriberesearchinprogressbytheauthor(s)andarepublishedtoelicitcommentsandtoencouragedebate.TheviewsexpressedinIMFWorkingPapersarethoseoftheauthor(s)anddonotnecessarilyrepresenttheviewsoftheIMF,itsExecutiveBoard,orIMFmanagement. ABSTRACT:Thispaperexploreshownon-U.S.centralbanksbehavewhenfirmsintheireconomiesengageincurrencymismatch,borrowingmoreheavilyindollarsthanjustifiedbytheiroperatingexposures.Webeginbydocumentingthat,inapanelof53countries,centralbankholdingsofdollarreservesaresignificantlycorrelatedwiththedollar-denominatedbankborrowingoftheirnon-financialcorporatesectors,controllingforanumberofknowncovariatesofreserveaccumulation.Wethenbuildamodelinwhichthecentralbankcandealwithprivate-sectormismatch,andtheassociatedriskofadomesticfinancialcrisis,intwoways:(i)byimposingexantefinancialregulationssuchasbankcapitalrequirements;or(ii)bybuildingastockpileofdollarreservesthatallowittoserveasanexpostdollarlenderoflastresort.Themodelhighlightsanovelexternality:individualcentralbanksmaytendtoover-accumulatedollarreserves,relativetowhataglobalplannerwouldchoose.Thisisbecauseindividualcentralbanksdonotinternalizethattheirhoardingofreservesexacerbatesaglobalscarcityofdollar-denominatedsafeassets,whichlowersdollarinterestratesandencouragesfirmstoincreasethecurrencymismatchoftheirliabilities.Relativetothedecentralizedoutcome,aglobalplannermaypreferstricterfinancialregulation(e.g.,higherbankcapitalrequirements)andreducedholdingsofdollarreserves. JELClassificationNumbers: E42,F4,G15 Keywords: Foreignreserves;centralbanks;currencymismatch;lenderoflastresort;financialregulation Author’sE-MailAddress: mdas@imf.org,ggopinath@imf.org,tkim@imf.org,jeremy_stein@harvard.edu *WearegratefultoHeleneHallforoutstandingresearchassistance.ThanksalsotoGoetzvonPeterandSwapan-KumarPradhanoftheBISforhelpinguswiththeBISdata,tonumerousIMFcountryteamsforobtainingand/orsharingcountry-leveldatawithus,andtoWenxinDuandIMFstafffortheirmanyhelpfulcomments. WORKINGPAPERS CentralBanksasDollarLendersofLastResort: ImplicationsforRegulationandReserveHoldings PreparedbyMitaliDas,GitaGopinath,TaehoonKim,andJeremyC.Stein1 1WearegratefultoHeleneHallforoutstandingresearchassistance.ThanksalsotoGoetzvonPeterandSwapan-KumarPradhanoftheBISforhelpinguswiththeBISdata,tonumerousIMFcountryteamsforobtainingand/orsharingcountry-leveldatawithus,andtoWenxinDuandIMFstafffortheirmanyhelpfulcomments. 1.Introduction Centralbanksaroundtheworldholdlargebalancesofforeigncurrencyreserves,withthe U.S.dollaraccountingforthedominantshareofthesereserves,atabout59%ofthetotal.1Intheaggregate,foreignofficialaccountsheld$7.06trillionofdollarsecuritiesinMarchof2022,with $4.06trillionofthisintheformofU.S.Treasurysecurities.2ThismakesforeignreservemanagersamongthemostimportantplayersintheTreasurymarket,afactthatisoftenarguedtobeakeydeterminantofthelevelofU.S.interestrates.3TheimplicationsofthesereservebalancesformarketoutcomeswerealsodramaticallyhighlightedintheCOVID-pandemic-induced“dashforcash”inMarchof2020,whenheavyforeigncentralbanksellingofTreasuriesplayedamajorroleinthedislocationsseeninthatmarket.4 Whatexplainsthelargeappetiteofglobalcentralbanksforforeigncurrencyreserves,andfordollarreservesinparticular?Inthispaper,wefocusononepotentialmotive,arisingoutofthefactthatfirmsinmanycountriesrunasignificantcurrencymismatchintheircapitalstructures,borrowingheavilyindollarsevenwhentheyhavelargelydomesticoperatingexposures.5Wearguethatinthefaceofsuchmismatch,acentralbankwillhaveanaturalincentivetostockpiledollars,sothatitcanmoreeffectivelyserveasalenderoflastresortinastateoftheworldwherethelocaleconomyandbankingsystemareunderstressandneedtobebailedout.Wethengoontoexplorethenormativeimplicationsofthisbehavior,showinghowthereserve-accumulationdecisionsofindividualcentralbankscanbeexcessiverelativetoaglobaloptimumtotheextentthattheydonotinternalizethegeneral-equilibriumimpactoftheirchoicesontheaggregatesupplyofsafedollarassetsandonthedollarinterestrate. Webeginbypresentingsomesimpleempiricalrelationshipstomotivateoursubsequenttheoreticalwork.Wedocumentthatinapanelof53countries,centralbankholdingsofdollarreserves(relativetoGDP)aresignificantlycorrelatedwiththedollar-denominatedbankborrowing 1Source:IMFCOFERdata. 2Source:TreasuryInternationalCapitaldata. 3EarlyanalysesoftheimpactofforeigndemandforU.S.d