Excessive euroization has proved to be a liability for all parties concerned: for the public, which became hostage to exchange rate risk without being properly hedged, for the central banks, which saw their transmission mechanism eroded, and even for the commercial banks themselves, which quite often had a large mismatch between loans and deposits in foreign currency. Moreover, some of the banks have extended credit in “exotic” currencies (Swiss franc, Japanese yen), the strict regulations in their home countries (Austria, Belgium) notwithstanding, thereby increasing the vulnerability to adverse shocks (Banai, Kiraly and Varhegyi, 2009). Would a predominantly domestically-owned private bank system have behaved differently? Probably, given the limited access to external financing and hence a more balanced portfolio. Witness in this respect the situation in Asia or Latin America, where foreign exchange credit did not skyrocket in the same way, even in times of economic boom. Other criticisms related to the behavior of foreign-owned banks during times of boom are, probably, undeserved: first, the claim that their lending went mainly into non-tradables, such as retail or real estate, where profits were larger and more rapidly made. Domestic private  BIS central bankers’ speeches  7  banks would have probably done exactly the same: empirical evidence points to the fact that they were not longer-sighted than their foreign-owned competitors. Second, foreign-owned banks are often criticized for “cherry-picking”, their customers being highly profitable, reliable corporations (often headquartered in the same state of origin).

But macroprudential measures need to be resorted to with a certain degree of precaution as well, since they may actually foster capital inflows and thus run counter to macroeconomic policies. Potential output declined severely in the aftermath of the crisis. A possible resumption in capital inflows would take aggregate demand higher and hence generate an inflationary production gap. Emerging countries would resort to fewer forex market interventions, allowing their currencies to appreciate in order to contain inflation. However, the long-term financial stability gains derived from macroprudential measures entail further capital inflows. The tolerance for currency appreciation (fewer interventions) may be reversed in light of the larger capital inflows. Moreover, a stronger currency may foster further inflows of portfolio investment. This goes to prove that not all measures trying to fend off capital flows are necessarily successful in reducing the incentives for capital inflows. Let me conclude by saying that the available measures to address large capital inflows are not safe from side effects. The policy mix needs to be conceived so as to maximize the benefits of capital inflows while insulating against related risks (Zhu, 2011). In a world where sustainable economic growth hinges on free markets, capital controls should only be considered as a measure of last resort, if at all. Prudential measures should be designed to minimize the distortions they trigger and should be resorted to only after all macroeconomic options have been exhausted. 6  BIS central bankers’ speeches  4. Foreign-owned banks – asset or liability?