Domestic or Foreign Currency? Remittances and the Composition of Deposits and Loans

This paper investigates the effects of remittance receipts on the currency composition of deposits and loans in the home-country banking system. For this objective, we first develop a simple model that links remittance flows to the decisions of households and firms with regard to the optimal share of deposits and loans, respectively, held in the form of foreign currency. We, then, examine empirically the relevance of the theoretical predictions for fourteen Central and Eastern European countries over the last two decades. Both the theoretical and empirical findings underpin the importance of remittances for the currency composition of bank’s balance sheets, pointing to a mismatch between deposits and loans: remittances raise the share of foreign currency loans whilst they reduce the share of foreign currency deposits.