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WHAT IS DRIVING FINANCIAL DOLLARIZATION IN TRANSITION ECONOMIES? A DYNAMIC FACTOR ANALYSIS

Published online by Cambridge University Press:  23 December 2013

Narayan K. Kishor and
Kyriakos C. Neanidis
Narayan K. Kishor*
Affiliation:
University of Wisconsin–Milwaukee
Kyriakos C. Neanidis
Affiliation:
University of Manchester and Centre for Growth and Business Cycle Research
*
Address correspondence to: Narayan K. Kishor, Department of Economics, University of Wisconsin–Milwaukee, Milwaukee, WI 53201, USA; e-mail: kishor@uwm.edu.
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Abstract

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This paper investigates the impact of institutions on the dollarization of the domestic banking system using a unique policy experiment: the process of accession of countries to the European Union (EU). Using a dynamic factor model, we decompose fluctuations in financial dollarization for 24 transition economies into a common factor, an EU factor, a non-EU factor, and country-specific factors. The EU factor, which proxies for improvements in institutions under the set criteria for eventual membership, reveals the importance of institutions for the extent of financial dollarization over time. The results also indicate the asymmetric impact of improved institutions on the domestic bank's balance sheets by inducing higher loan dollarization and lower deposit dollarization. The relative importance of the EU factor to the financial dollarization of a country is associated to the degree of comovement of its business cycle with that of the EU.

Keywords

Financial DollarizationInstitutionsEuropean Union

References

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