Risk Management of Dollarization in Banking: Case of Post-Soviet Countries

Abstract

Dollarization of bank assets and liabilities is a typical phenomenon with multi-faceted effects. Primarily, this phenomenon raises risks of imbalance in assets and liabilities following a sharp local currency devaluation. However, dollarization may deliver additional returns. This calls for development and implementation of strategies for dollarization risk management. This study aims at designing risk management strategies for ensuring optimal currency structure of loan and deposit portfolio under an extremely high level of devaluation risk in six post-Soviet countries. The study is based on risk modeling methods and asset liability management techniques. The value-at-risk methodology is applied to measure and identify main risks banks face under dollarization. Two types of risk are identified: the strategic risk measured as a ratio of deposits in foreign currency; and the tactical risk measured as a ratio of foreign currency deposits transformed into local currency loans. Suggested effective risk management strategies are based on the optimization of these two types of risks. The first strategy deals with deposit dedollarization and non-transformation of foreign currency deposits into local currency loans. Under the second strategy, increased deposit dollarization is complemented with non-transformation of foreign currency deposits into local currency loans. The third strategy involves deposit de-dollarization and conducting transformation of foreign currency deposits into local currency loans. Each strategy entails maximization of return with subsequent minimization of risk. The study concludes that the first strategy is appropriate for Ukraine and Belarus, the second one suits Azerbaijan and Moldova, and the third one fits Armenia and Georgia.