Annex 1. Country Experiences in Managing FX Credit Risk
This annex surveys the experiences with specific prudential measures managing FX credit risks. Measure have not been widely use despite being a considerable threat to financial stability. The main challenge is to ensure that financial institutions have in place internal mechanisms to adequately qualify, define, and manage credit risks associated with lending to unhedged borrowers. In parallel, close monitoring and supervision would be crucial to ensure financial institutions internalize correctly FX credit risk. In parallel, measures to encourage the adequate use of FX hedging among the household and corporate sectors would be welcome.
As a first step, country authorities need to do more to compile detailed information about the financing structure of the corporate and household sectors, with emphasis on FX mismatches and exposure to complex financial instruments like derivatives. To properly internalize FX credit risks, information is required on FX position, FX sales and percentage of short-term liabilities in foreign currency from the borrowers, which may prove challenging. At times of easy external financing conditions, corporates and households tend to increase indebtness, in many cases raising FX mismatches because of more attractive financial terms.
Prepared by Mercedes Vera Martin. The note has benefited from comments by C. Fernandez, M. Garcia-Escribano, and C. Tovar.
For a discussion on measures to limit FX positions in banks’ balance sheets, see accompanying note “Limiting Foreign Exchange Positions to Contain Systemic Risk,” prepared by C. Fernández-Valdovinos and Chris Walker (WHD).
Ultimately, Peru is moving toward a system in which banks would incorporate the FX credit risk in the overall assessment of credit risk (through higher internal ratings (like currently done in Chile).
Data on deposits excludes nonresident deposits.
The discussion in this section is drawn from “Credit Growth: Development and Prospects” (A. Tiflin, Selected Issues Paper, 2006 Article IV Consultation, IMF/06/169); and Romania’s financial sector stability report (IMF, 2010e); available at www.imf.org/external/pubs/ft/scr/2010/cr1047.pdf.
Additional measures included increases in foreign-currency reserve requirements, also to curb capital inflows.
See IMF (2010e) for a detailed analysis of Romania’s financial sector stability at www.imf.org/external/pubs/ft/scr/2010/cr1047.pdf
This section is drawn from Jara, Moreno and Tovar (2009).
The problem extended also to productive companies in India, China, and Korea. See Farhi and Zanchetta (2009) for details.
A major food retailer (Comercial Mexicana) sought bankruptcy protection in October 2008 with losses up to US$1.1 billion on non-deliverable forward (NDF) contracts it had made with international banks Gruma SA, the world’s largest maker of corn flour, and Alfa SAB, the world’s largest maker of aluminum engine heads and blocks, also suffered from considerable mark to market losses on derivative instruments during this period. In October, glass maker Vitro SAB announced that a large part of its $227 million of derivatives losses had come from natural gas forwards.