Prudential Responses to de facto Dollarization

We present a model that encompasses three distinct motives for dollarization (price volatility, credit risk, and moral hazard) and discuss when risk-based prudential policy responses are called for and the form they should take. We argue that the overall policy response must be tailored to the nature of the dollarization the economy is facing. However, prudential policies should be formulated irrespective of the roots of dollarization. Their aim should be to enhance financial stability by ensuring that banks internalize credit risk within acceptable risk tolerance levels, taking dollarization and the current monetary policy environment as given.