Role of Original Sin and Currency Mismatches on Currency, Banking and Debt Crisis

Abstract

The global financial crisis has sparked an interest in the association between financial crises and currency mismatches. This study investigates the role of external vulnerable indicators in crises prediction. We contribute to the literature by constructing a broader version of original sin that includes currency composition of international debt securities and cross-border banking loans for 165 countries from 1970 to 2018. We also measure the new currency mismatch index using broad original sin and find that re-emerge the problem of original sin and currency mismatches in emerging developing and economies (EDEs) during the post-global financial crisis. We identify the global and macroeconomic factors that could contain valuable information to uncover external vulnerabilities leading to financial crises. Our findings suggest that higher value of original sin and currency mismatches associated with a more likelihood of currency, debt, and banking crisis and support the third-generation crisis models. Further, to improve the resilience of EDEs, the policymakers need to implement effective monetary and fiscal policy frameworks. Finally, EDEs should raise forex reserves and limit foreign currency borrowings.