Cross-Sectional Determinants of Bank Performance under Deposit Dollarization

Dollar-denominated deposits constitute a large proportion of deposits in many developing economies. This may result in currency mismatches on banks' balance sheets as is suggested by recent literature. In general, having dollar-denominated deposits and loans could increase financial fragility, create balance sheet problems and affect bank profitability. In particular, this currency mismatch does not only increase banks' currency risk when the proportion of dollar-denominated loans with respect to local-denominated loans increases but also it increases their clients' default risk if depreciation occurs. This paper investigates the profitability of 36 dollarized banking systems. Our results suggest that after controlling for some macroeconomic and institutional variables, dollarization, as currency mismatch hypothesis suggests, depresses bank performance and lowers bank profitability. Moreover, our results show that the effect of institutions more than offset the negative impact of dollarization on banks' profitability