Evaluating the Effects of Deposit Dollarization in Financial Intermediation in Transition Economies

The dollarization of bank deposits in developing economies may result in a currency mismatch in domestic banking activities, as recent literature has suggested. This may, in return, increase financial fragility, create balance sheet problems, and affect bank profitability in such economies. This paper empirically tests the effect of dollarization on bank performance in nine dollarized transition economies. We fail to find empirical evidence to support the assertions of the currency mismatch theory. Our results suggest that though there is no direct link between bank profitability and dollarization in these economies, the high level of deposit dollarization lowers the level of provisions set aside for banks' loan losses.