Sterilization of capital inflows through the banking sector: evidence from Asia

This paper develops an open-economy version of the Bernanke-Blinder model which indicates that sterilization efforts through increases in reserve requirements will have limited impact if viable financial alternatives to the commercial banking sector exist. I then examine the capital inflow surge experiences of seven developing Asian nations. Our analysis yields three stylized conclusions: First, the timing of capital inflow surges indicates a causal role for both domestic and foreign factors. Second, there is little general rule as to the most effective sterilization instrument. Finally, the experiences of the developing nations during their capital inflow surge period largely coincide with the predictions of the model. Korea, the country with the largest nonbank financial sector, had the least success in stemming the impact of capital inflow surges despite intervention through both open market operations and increased reserve requirements.