The Determinants of Financial Euroization in a Post-Transition Country: Do Threshold Effects Matter?

This paper investigates the long-run and short-run determinants of financial euroization (FE) using both linear and threshold models. We model deposit euroization (DE) and credit euroization (CE) in Croatia, a post-transition country recording very high and persistent unofficial FE. The results suggest that only the portfolio view is important for explaining DE and CE. The market failure view does not seem to matter for FE in Croatia. Both nominal and real exchange rate changes have a strong effect on FE in the long run; the former is more important for DE and the latter for CE. In the short and long run CE is also determined by matching behavior of banks’ foreign currency positions. Both DE and CE respond to changes in inflation and exchange rate volatility. Threshold cointegration confirms that FE determination is subject to significant threshold effects, while error correction models suggest that FE adjustment is very slow and asymmetric, partly due to very strong FE persistence.