An undue focus on banks

In an interesting and important recent Voxeu article Pınar Yeşin states, about lending in a foreign currency (emphasis added),

While foreign currency loans offer some advantages to borrowers – such as lower interest rates and longer maturities compared to domestic currency loans – they also carry a significant exchange rate risk. A sharp depreciation of the domestic currency can prevent unhedged borrowers from being able to service their foreign currency loans. As a result, these loans could create a substantial systemic risk to the European banking sector. Banks could fail jointly as a result of their exposure to unhedged households and non-financial firms which default on their loans when the domestic currency depreciates sharply.

Policymakers and international institutions have recognised the systemic risk that foreign currency loans pose to the European banking sector. For example, the European Systemic Risk Board (ESRB), an independent institution monitoring financial stability within the EU, made an official recommendation on lending in foreign currency on November 22, 2011. In particular, the ESRB stated that “Excessive foreign currency lending may produce significant systemic risks for those member states and may create conditions for negative cross-border spillover effects.”

But the real problem is not lending in a foreign currency. The real problem is borrowing a foreign currency.

One of the problems with economics (as well as economists) is an undue focus on the financial sector (including pension funds) and financial assets. And the larger problem of a monetary crisis is not the systemic risk to the banking sectors and an increase in non-performing assets (which are problems in their own right, to be sure) but households and non-financial companies which have to default. It´s not about banks. It´s about families and households. As Stiglitz, Sen and Fitoussi argue, economic statistics have to become more household oriented to enable a shift of economic thinking towards the important questions. Which, according to Mahé, Schrijvers and me, is entirely possible when it comes to monetary statistics. Even when it is, as in this case, about the original sin in economics – borrowing in a currency which your country does not control. Which in this case also means that it´s not about protecting the value of the assets of the financial sector (i.e. protecting wealth and creditors) but about guaranteeing the circular flow of money and income (i.e. protecting the income of households and companies which, by the way, is better for the banks too).