Regulatory and Supervisory Reform: Going back to Basics:

The Latin American Perspective

MÓNICA APARICIO SMITHMÓNICA APARICIO SMITH

Madrid, June 15, 2009

Table of contents

1. The origins of the financial crisis and its impact on LAC

2. Why LAC has been less vulnerable than in previous episodes?

3. Regulatory and supervisory changes.

4. The financial safety net and the deposit insurance.

2

After Mar/09From sep/08 to

feb/09 (After Lehman)

In contrast to previous episodes, LAC countries have not been the origin of the crisis, nor

have contributed to its deepening. Instead, the origin of this crisis has been the breakdown

of the American economy, as a result of its monetary policy, its financial regulation and

supervision, its subsidies policies which generated an asset price bubble, its inadequate

risk measurement, its management incentive policies, etc. It is difficult to find a bigger

package of errors.

Facing the crisis, LAC countries have experimented three moments:

1. The origins of the financial crisis and its impact on LAC

Before sep/08

• Some Governments

and experts argued

that LAC would

remain immune to the

possible crisis effects

(Decoupling).

• The crisis hit the region,

fostering deep plunge in the

stock market, depreciations

of local currencies and

sudden stop of capital flows.

• LAC markets “cooled

down” due to the

stabilization of world market

indicators and to the

relatively strengthen of LAC

financial systems.

3

Due to the advances LAC countries have made during the last decade, the region

is now better prepared to deal with a financial crisis:

Macroeconomic factors

Today, macroeconomic “fundamentals” of the majority of the LAC economies

are more robust, as a result of the world economic “boom”: Fiscal Imbalances are

improved and current account deficits almost disappeared.

Macroeconomic reforms in many LAC countries on inflation-targeting regimes,

floating exchange rates and counter cyclical monetary policies helped.

2. Why has LAC been less vulnerable than in previous episodes?

4

-5.7%

-3.1%-4.3%

1.5%

-0.7%

1982 1994 1998 2006 2008

Source: IMF, WEO (2009)

Current account balance in LAC % of GDP

Overall balance in LAC-7* % of GDP

External debt in LAC % of GDP

45%

33% 37%

24% 21%

1982 1994 1998 2006 2008

Source: IMF, WEO (2009)

-0.6%

-2.3% -2.7%

1.2%

1990 1994 1998 2006 2008

n.a.

* LAC-7 includes Argentina, Brazil, México, Chile, Colombia, Peru and Venezuela.Source: IADB

In fact, LAC has strengthened its monetary, fiscal, and external fronts

60

80

100

120

140

ene-06 sep-06 may-07 ene-08 sep-08 may-09Argentinian peso Brasilian real Mexican pesoChilean peso Colombian peso

Exchange rate index (January 2006=100)

Source: Bloomberg 5

LAC countries have been able to adopt counter-cyclical macroeconomic policies

Monetary policy Fiscal policy

LAC countries that have adopted or announced expansive policies (% of the sample 1/)

81.8%

63.6%54.5%

63.6%

Sectorial policies(housing, tourim,

etc)

TAX reduction Increase of publicexpenses

(infrastructure)

Socialprogrammes

Source: CEPAL1/ 33 countries in LAC

Source: IADB

Brazil

5%

10%

15%

20%

Ene-06 Jul-06 Ene-07 Jul-07 Ene-08 Jul-08 Ene-09

Mo

net

ary

po

licy

rat

e

2%

3%

4%

5%

6%

7%

Infl

atio

n

Monetary policy rate Inflation 6

Colombia

5%

7%

9%

11%

13%

Ene-06 Ene-07 Ene-08 Ene-09

Mo

net

ary

po

licy

rat

e

0%

2%

4%

6%

8%

Infl

atio

n

Monetary policy rate Inflation

Chile

0%

2%

3%

5%

6%

8%

9%

Ene-06 Ene-07 Ene-08 Ene-09

Mo

neta

ry p

oli

cy

rate

0%

2%

4%

6%

8%

10%

Infl

ati

on

Monetary policy rate Inflation

Governments, bankers and depositors of the region have learned from the financial crises

lived in the last twenty years. 12 countries in Latinamerica lived a major financial crisis

during the nineties.

LAC´s financial systems have adjusted their prudential regulation to international

standards (capital requirements and provisions). Current figures show solvency ratios

above 13%.

LAC financial institutions have reduced their exposure to US dollar assets and liabilities.

Foreign bank branches in LAC countries, which hold an important portion of these

financial markets, fund their positions mainly with local deposits instead of cross border

operations.

Microeconomic factors

7

2. Why has LAC been less vulnerable than in previous episodes?

The underdevelopment of LAC´s capital markets explained the low amount of

toxic assets hold by the banks of the region.

Many LAC countries established capital controls and limits on bank's exposure

to financial innovations ( complex derivates and structured products).

In most LAC countries, the share of state-owned banks in their financial

systems has declined in an important way.

Microeconomic Factors (continuation)

8

2. Why LAC has been less vulnerable than in previous episodes?

0% 10% 20% 30% 40% 50%

Jamaica 96

Rep. Dominicana 03

Ecuador 98

Uruguay 02

México 94

Colombia 99

Venezuela 94

Brasil 94

Paraguay 95

Argentina 01

Bolivia 94

Argentina 95

Source: Laeven y Valencia (2008).

Colombia 99 estimation Fogafin.

As a response to the financial crises the region lived in the nineties, LAC´s financial systems started a strengthening process

9

Capital adequacy ratio(Regulatory capital to risk weighted assets)

Nonperfoming Loans ratio

Fiscal Cost of financial crisis% of GDP

Source: IMF, Regional economic outlook: Western Hemisphere. May 2009

The international debate on reforming the financial regulatory framework has just

started. LAC countries should not rush to implement new measures without

balancing their implications.

In low developed financial markets, such as LAC, it is important to avoid the

temptation of “over-regulate” and “over-intervene” the financial activity, under the

premise that the financial integration is a threat to the economic growth.

Risk assessment statistical models do not substitute: good management,

business knowledge, adequate in-situ supervision, and prudential regulation.

According to some important authors, the focus of the regulatory reform should

not be only on capital requirements. The main problem of the actual crisis is the risk

measurement.

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3. Regulatory and supervisory changes.

3. Regulatory and supervisory changes

Macro prudential policies: In order to face the asset price bubble and financial

instability, central banks should make efforts to accelerate the transmission

channel from the monetary policy to the credit and expense channel(Colombian

case).

Prudential regulation should increase capital requirements and provisions in

“good times” as function of credit growth and asset price growth so financial

institutions will have a “back-up” during recessions.

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4. The Financial Safety Net and the Deposit Insurance

Regulator

Deposit Insurer

SupervisorFINANCIAL

SYSTEM

Lender of last resort

Coordination among safety net participants.

Universal deposit insurance coverage vs. market discipline. Today we have an implicit and explicit deposit insurance.

Too big to fail vs. Moral Hazard.

Role of the financial safety net dealing with “non-bank financial intermediaries”.

Main topics

12

THANK YOU