By Rodrigo Campos

NEW YORK (Reuters] – The most sensitive banks in Latin America or emerging Europe to dollarization are those in developing economies. They face weaker currencies and greater withdrawals due to tighter U.S. monetary regulations, Moody’s (NYSE 🙂 reported on Monday.

Moody’s believes that interest rate increases by the U.S. Federal Reserve will slow down capital flow to emerging markets. This could weaken currencies and cause economic growth to be slower. It also may trigger credit risk for highly dollarized banks.

Moody’s analysts stated that banks holding large amounts of foreign-currency deposits and loans are at risk from a sudden spike in credit losses. This could lead to pressure on profitability and liquidity, as well as increased risks when the value of local currency falls sharply.

It becomes more difficult for non-hedged borrowers repay foreign-currency loan repayments, while depositors have the tendency to withdraw funds. In times of crisis, financial stability can be threatened by high dollarization. This is because central banks may not have enough foreign currency reserves to bail out bank with shortfalls in dollars.

Moody’s discovered that dollars deposits were highest in Latin America and emerging Europe banks, but are relatively low in Africa and Asia Pacific. A strong currency reserve offsets a higher level of exposure in the Gulf countries.

High inflation in Uruguay and a steady decline of the peso has pushed the country up to the top Moody’s Dollarized Countries list, where 74% deposit. A trend that will continue. The 10% savings rate from nonresidents will not change, mainly in neighboring Argentina. In Argentina, inflation is predicted to rise by the end of this year.

Turkey is another emerging economy where hard-currency deposits are held. Locals have had to deal with high inflation, a weakening currency and excessive dollar deposits. Dollar deposits will rise to 65% in 2022 from just 47% and 63% in 2020.

Moody’s stated that retail depositors convert substantial amounts of local currency deposits to foreign currency, mainly U.S. Dollars to safeguard their savings against inflation and depreciation.

Argentina’s foreign currency deposits dropped sharply from 40% to 16% after the 2019 elections. This was due to loss of confidence.

Moody’s warned that “there is a possibility of additional outflows from dollar deposits if trust in public policies or central bank deteriorates more,” and noted that banks would need support in times of crisis if they had very few to no foreign-currency reserve.

In the near-term, there will be a trend of lower dollarization in Azerbaijan and Ukraine, as well as in Armenia, Kazakhstan, Peru, Ukraine, and Peru. However, banks in Azerbaijan (Armenia), Belarus, and Peru are most vulnerable to non-hedged borrowers because they do not have income from the foreign currency used for the loan.