📈 economics

The impact of net foreign-asset deficits on private credit: banks versus central banks in IMF-programme economies

This study of eight IMF-programme economies finds that while banks' net foreign asset deficits do not significantly constrain private credit, central bank reserve shortages act as a binding constraint with a strong, asymmetric long-run impact, where declines in official reserves reduce credit far more severely than equivalent increases boost it.

Original authors: Mohamed Ramadan Saeed Mohamed Ahmed Hassan

Published 2026-10-20

📖 5 min read🧠 Deep dive

CC BY 4.0

Original authors: Mohamed Ramadan Saeed Mohamed Ahmed Hassan

Original paper licensed under CC BY 4.0 (https://creativecommons.org/licenses/by/4.0/). ✨ This is an AI-generated explanation of the paper below. It is not written or endorsed by the authors. For technical accuracy, refer to the original paper. Read full disclaimer

In the world of international finance, countries often face a shortage of foreign currency, the hard money needed to buy goods from abroad or pay off international debts. When this happens, two main groups hold the keys to the economy: the commercial banks that lend to businesses and families, and the central bank, which acts as the nation's financial guardian. Both groups keep a stash of foreign assets, like dollars or euros, to ensure they can meet their obligations. If these stashes run dry, the flow of money within the country can stall. The crucial question for economists and policymakers is which of these two groups runs out of money first, and how that shortage stops the rest of the economy from borrowing and spending. Understanding this distinction is vital because the solution depends entirely on the answer: if the problem lies with the commercial banks, the fix involves tightening their rules; if the problem lies with the central bank, the fix involves rebuilding the nation's official savings.

A recent study by researcher Mohamed Ramadan Saeed Mohamed Ahmed Hassan investigates exactly this dynamic in eight emerging economies that have recently relied on support from the International Monetary Fund. These nations, including Argentina, Egypt, Pakistan, and Ghana, faced severe currency shortages between 2022 and 2024. The researcher gathered detailed quarterly records from the International Monetary Fund, looking at the balance sheets of both the commercial banks and the central banks in these countries over a period spanning from 2001 to 2026. The goal was to see whether a drop in the foreign assets held by commercial banks or a drop in the foreign assets held by the central bank had a bigger impact on the amount of credit available to private businesses and individuals.

The study began by testing a common assumption: that if a commercial bank loses its foreign money, it must immediately stop lending to the local economy. The logic was that without foreign cash, a bank cannot fund its loans. However, the data told a different story. When the foreign assets held by commercial banks fell, private credit did not shrink. In fact, in the short term, a drop in these assets was often followed by an increase in lending. The researcher found that banks were likely using their foreign savings as a reserve to fund new loans at home. When lending opportunities looked good, banks would dip into their foreign stash to pay for domestic loans, causing their foreign asset balance to drop while credit to the private sector rose. This suggests that a deficit in a commercial bank's foreign holdings is often a sign of active lending rather than a sign of financial distress.

The picture changed completely when the researcher looked at the central bank. The central bank's foreign assets, which represent the nation's official reserves, behaved very differently. When the central bank's foreign assets fell, the amount of credit available to the private sector dropped significantly. The study found that for every one-point decrease in the central bank's foreign assets relative to its total size, real private credit fell by about 2.5 percent in the long run. This effect was not just a temporary blip; it took a long time for the economy to recover, with the full impact unfolding over several years. The data showed that rebuilding these official reserves was far more critical for restoring credit than fixing the foreign positions of individual commercial banks.

Perhaps the most striking discovery was that the damage done by losing money was not the same as the help gained from finding it. The study revealed a sharp asymmetry in how the economy reacted. When the central bank lost foreign assets, the hit to private credit was severe and lasting. However, when the central bank gained foreign assets, the boost to credit was much smaller, rising by only about 0.8 percent for a similar one-point increase. This means that the pain of a reserve shortage is roughly three times more powerful than the relief provided by a reserve surplus. The researcher noted that this imbalance is likely because central banks, fearing a crisis, move very slowly to rebuild their buffers after a shock, keeping interest rates high and credit tight until they feel completely secure again.

The findings hold up even when the researcher tested different ways of analyzing the data or removed specific countries from the group. The results remained consistent: the central bank's position is the primary driver of credit availability in these economies, while the commercial banks' foreign positions are secondary. The study concludes that for policymakers trying to revive an economy after a currency crisis, the priority should be rebuilding the central bank's official foreign reserves. Trying to restrict the foreign activities of commercial banks is less effective, as those banks are often using their foreign assets to support domestic lending rather than holding them back. The path to recovery is slow, but the data makes it clear that the nation's official savings are the true foundation upon which private credit stands.

Technical Summary: The Impact of Net Foreign-Asset Deficits on Private Credit

Problem Statement
Between 2022 and 2024, several emerging and frontier economies experienced acute foreign-currency shortages, leading to negative net foreign assets (NFA) for both commercial banks and central banks. While existing literature establishes that foreign funding influences domestic credit and that international reserves cushion crises, a critical gap remains: it is unclear which balance sheet position—the commercial bank's or the central bank's—constrains private credit more significantly during such shortages. Furthermore, most studies assume symmetric effects, whereas theoretical arguments suggest that deteriorations and improvements in NFA may have non-mirror-image impacts on credit due to financial frictions and central bank behavior. This study investigates whether bank-level NFA deficits or central bank NFA deficits are the primary constraint on private credit in IMF-programme economies and tests for asymmetric effects.

Methodology
The study utilizes quarterly balance-sheet data from the International Monetary Fund (IMF) for eight economies with IMF-supported programmes (Argentina, Bangladesh, Egypt, Ghana, Kenya, Pakistan, Sri Lanka, and Zambia) covering the period 2001–2026. The sample excludes Ethiopia due to missing bank balance-sheet data and adjusts for reclassification breaks in Pakistan, Ghana, and Sri Lanka.

The core empirical strategy employs a Panel Nonlinear Autoregressive Distributed Lag (NARDL) model, estimated using the Pooled Mean Group (PMG) estimator (Pesaran et al., 1999). Following Shin et al. (2014), the NFA ratios for both banks and central banks are decomposed into partial sums of positive and negative changes ( $x^+$ and $x^-$ ) to capture potential asymmetries. The dependent variable is the log of real private credit.

The model specification includes:

Long-run relation: $C_{it} = \theta^+_B B^+_{it} + \theta^-_B B^-_{it} + \theta^+_Z Z^+_{it} + \theta^-_Z Z^-_{it} + u_{it}$ , where $C$ is real private credit, $B$ is the bank NFA ratio, and $Z$ is the central bank NFA ratio.
Short-run dynamics: An error-correction form incorporating lagged differences, country-specific intercepts and trends, seasonal dummies, and currency depreciation against the US dollar as a control.
Robustness checks: The study compares PMG estimates with Mean Group (MG) and Dynamic Fixed Effects (DFE) estimators. It also employs asymmetric local projections (Jordà, 2005) to trace impulse responses over an eight-quarter horizon. Diagnostic tests include the CIPS unit-root test and Pesaran's cross-sectional dependence (CD) test.

Key Contributions

Comparative Analysis: Unlike previous studies that often treat bank and official positions separately or focus on flow variables, this paper simultaneously models the stock constraints of both commercial bank and central bank NFA ratios within a single framework.
Asymmetry Testing: The study explicitly tests for non-linearities, examining whether credit contractions resulting from NFA losses are larger than expansions resulting from NFA gains, addressing the "credit-less recovery" phenomenon.
Focus on IMF Economies: The analysis specifically targets economies currently or recently under IMF programmes, a group under-represented in existing literature regarding foreign-currency shortages.

Results

Bank NFA: The study rejects the hypothesis that a fall in banks' own NFA reduces private credit. In the long run, bank NFA has no significant effect on real private credit. In the short run, falls in bank NFA are associated with increases in credit, consistent with banks drawing down foreign assets to fund domestic lending.
Central Bank NFA: The central bank's position is the primary constraint. A one-point fall in the central bank's NFA ratio (as a share of total assets) is associated with a long-run reduction in real private credit of approximately 2.5%. Conversely, a one-point rise is associated with an increase of only 0.8%.
Asymmetry: The results confirm significant asymmetry (H3) for the central bank's position. Losses of official foreign assets weigh on credit roughly three times as much as equal gains help it. This asymmetry is robust across different sample specifications and lag orders but disappears when common quarterly shocks are removed via cross-sectional demeaning, suggesting the effect is driven by shared external stress transmitted through official reserves.
Adjustment Speed: The error-correction coefficient indicates a slow adjustment process, with a half-life of deviations of approximately 18 quarters.

Significance and Claims
The paper concludes that in the context of IMF-programme economies facing foreign-currency shortages, the "official-buffer channel" dominates the "bank funding channel." The findings suggest that:

Policy Priority: Rebuilding official foreign-currency buffers is more critical for restoring private credit than tightening limits on banks' net open positions, as bank NFA deficits often signal active lending rather than constraint.
Recovery Dynamics: Credit recovery following reserve rebuilding is inherently slow and asymmetric. Policymakers should anticipate a lag in credit recovery even after reserves are replenished, as inflows first clear import backlogs and restore reserves before reaching bank lending.
Interpretation of Signals: A deficit in banks' NFA should not be automatically interpreted as a sign of credit stress, as it frequently coincides with credit expansions.

The author notes limitations, including the inability to fully separate credit supply from demand with aggregate data and the reliance on shared external shocks for identification. However, the robustness of the central bank's asymmetric effect across various estimators and specifications supports the conclusion that official reserves are the binding constraint on private credit in these economies.

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