Dear Isolda

I think the belowed paper may have some information for you

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=983483

Best

Canh

Dollarization plays a dual role: on one side, it provides a hedging instrument protecting the value of savings and, on the other side, it generates currency mismatch on banks’ balance sheets and increases default risk. Through these effects deposit dollarization can impact credit extension.Banks in highly dollarized economies face risks that significantly affect their ability to perform their financial intermediate role. 

The following paper may help you:

I think you have to distinguish between unofficial dollarization, which often occurs in high inflation and hyperinflationary countries as people try to avoid the effects of inflation, and official dollarization economies (like Panama, El Salvador and Ecuador). Zimbabwe experienced both, an unofficial dollarization that ultimately resulted in an official dollarization, once the RBZ could no longer print new notes. In unofficial dollarization economies, if banks get involved with that activity, some of it might be viewed as illegal or quasi-illegal if it's illegal but permitted, which would add risk premia to that activity. For the effects of official dollarization, see this Atlanta Fed 2006 study: https://www.frbatlanta.org/research/publications/economic-review/2006/q3/vol91no3_banking-system-in-ecuador-and-el-salvador.aspx

The paper attached discusses the effects of dollarization on Ecuador`s banking system, and the role these effects played in forcing Ecuador`s January-2000 decision fully to dollarize its economy.

thanks a lot to all for helping me

Hi Isolda,

I understand that you mean what happens in an economy that becomes dollarized completely, not only allowing deposits and loans in dollar.

In my personal opinion, in that case the first effect normally is a decrease in the interest rates managed by the Central Bank and the financial system, this decrease will be dependent from another factors as the macro situation: if the country risk spread is high due for example to a high fiscal deficit then the decrease in interest rate will be lower. Normally the interest rate will be the 10 years US Bonds plus (+) the risk spread.

For example, the interest rates will be 2% following the 10 years US Bond plus 5% the spread leading to a 7% interest rate. The same applies to deposits.

Another effect is a decrease in the inflation rate due to monetary restrictions (that I explain further), an increase in market confidence due to taking out the exchange rate risk and confidence due to work with a solid currency as dollar. The inflation rate will be affected also by the rate of investment to fulfil the economy necessities. The inflation is also affected by a freeze or decrease in salaries: as you can’t devaluate your currency the only way to make your salaries competitive is through a decrease in salary cost or at least a freeze upon them.

One very important problem is that as the Central Bank has no more the faculty over the money issue, as the currency volume is managed by the Fed, then the Central Bank of the dollarized economy will depend on the reserves in foreign currency, mainly the dollar. These reserves are increased by exports, foreign debt and direct foreign investments. Thus the monetary policy of the Government is quite constrained and you’re more tight to the evolution of the economy in general and the productivity in particular.

Related directly with the loans the country can experiment a credit rationing due to a lack of dollars in the reserves, if the Central Bank wants to increase the money offer to the financial system then it will depend on the capacity of the CB to obtain foreign currency mainly dollar (because the CB can’t issue money autonomously).

This is my opinion about your question, probably not all the people would agree and for sure I’m missing another situations but I believe that is not very far from reality.

Kind regards.

My new article is about the interesting effects of dollarization in Iran. It seems there would be a similar result for all of developing countries.

Isolda Zgheib Followings are the helpful publication link:

Article Deposit Dollarization and its Impact on Financial Deepening ...

http://vcentrum.pucp.edu.pe/investigacion/wps/pdf/CEFE_WP2012-09-0002.pdf

Full dollarization creates positive investor sentiment, almost extinguishing speculative attacks on the local currency and the exchange rate. The result is a more stable capital market, the end of sudden capital outflows, and a balance of payments that is less prone to crises.