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

This paper explores how non-U.S. central banks behave when firms in their economies engage in currency mismatch, borrowing more heavily in dollars than justified by their operating exposures. We begin by documenting that, in a panel of 53 countries, central bank holdings of dollar reserves are significantly correlated with the dollar-denominated bank borrowing of their non-financial corporate sectors, controlling for a number of known covariates of reserve accumulation. We then build a model in which the central bank can deal with private-sector mismatch, and the associated risk of a domestic financial crisis, in two ways: (i) by imposing ex ante financial regulations such as bank capital requirements; or (ii) by building a stockpile of dollar reserves that allow it to serve as an ex post dollar lender of last resort. The model highlights a novel externality: individual central banks may tend to over-accumulate dollar reserves, relative to what a global planner would choose. This is because individual central banks do not internalize that their hoarding of reserves exacerbates a global scarcity of dollar-denominated safe assets, which lowers dollar interest rates and encourages firms to increase the currency mismatch of their liabilities. Relative to the decentralized outcome, a global planner may prefer stricter financial regulation (e.g., higher bank capital requirements) and reduced holdings of dollar reserves. ∗ We are grateful to Helene Hall for outstanding research assistance. Thanks also to Goetz von Peter and SwapanKumar Pradhan of the BIS for helping us with the BIS data, to numerous IMF country teams for obtaining and/or sharing country-level data with us, and to Wenxin Du and IMF staff for their many helpful comments. The views expressed in this paper are those of the authors and do not necessarily represent the views of the IMF, its Executive Board, or IMF management. 1