Lending-Rate Spreads, Financial Dollarization, and Creditor Protection

This paper proposes an explanation for loan-rate spreads between middle-income countries and financial centers based on lack of creditor protection and currency mismatch. The evidence suggests that firms that export little (or nothing) are more currency-mismatched than firms that export a large proportion of their output. The model uses this fact to explain how the relative importance of different sectors can lead to higher equilibrium loan rates in a standard open-economy model of credit-market imperfections based on Bernanke, Gertler, and Gilchrist (1999). In the model, firms borrow in dollars but differ on whether they have dollar-liquid or peso-liquid collateral. Because exchange-rate fluctuations change both the probability of default and the default-case returns, exchange-rate variability leads to higher loan rates, more so if creditor protection is low and currency mismatch is high