The Impact of Deposit Dollarization on Credit Dollarization: Evidence of Natural Hedging and Excessive RiskTaking Channels

This article studies the impact of deposit dollarization on credit dollarization through the natural hedging and the excessive risk-taking channels. We develop a theoretical model that helps us to describe both channels and how these determine the direction in which deposit dollarization might affect credit dollarization. The model shows that through the natural hedging channel, deposit dollarization positively affects credit dollarization, while through the excessive bank risk-taking channel, deposit dollarization negatively affects credit dollarization. Using regional data of credits and deposits in Peru, we find evidence of these two channels, with the natural hedging channel being the dominant one. In addition, we reveal that les credit market competition and high FX uncertainty amplify the role of the excessive bank risk-taking channel.