International Regulation and Supervision: A Solution to Bank Failure in Latin America?

By Minda, Alexandre; Truquin, Stéphanie | Ibero-americana, January 1, 2005 | Go to article overview

International Regulation and Supervision: A Solution to Bank Failure in Latin America?


Minda, Alexandre, Truquin, Stéphanie, Ibero-americana


I. INTRODUCTION

The assessment of Latin America's insertion into the globalization process is a very delicate question. The ECLAC (Economic Commission for Latin America and the Caribbean) described the 1980s as the "lost decade for development". In spite of the sweeping political democratization, the depletion of an industrialization model based on import substitution and the debt crisis precipitated a fall in per capita income. During the 1990s, the move towards a more outward oriented strategy of industrialization and adjustment programs brought about economic progress, such as disinflation, productivity gains, and the diversification of national production capacities and the growth of per capita income. However, because of repeated financial crises and the absence of significant social progress we cannot say that it was a "victorious decade".

Despite the introduction of wide reforms, financial stability in Latin America remains frail. The opening up of frontiers has rendered the subcontinent more vulnerable to international financial movements and to the economic changes in large developed nations. The Mexican, Brazilian and the recent Argentine crises are examples of the financial instability of the region. Like foreign exchange and financial crises, banking crises are outward signs of this instability. An investigation of the banking sector is therefore fundamental because of its specific and particular role in the economy of a country. The banking sector plays an essential part in raising and allocating capital in emerging economies where it intervenes more in financial intermediation than it does in developed countries. In Latin America, where financial markets are unevenly developed, banks are the only institutions able to give enough information to produce positive externalities.

However, banks evolve in an asymmetric information environment and are particularly prone to the imperfections of the market. They are intrinsically fragile. The fact that banking assets are less liquid than money balances makes their financial terms more burdensome and dependent on the confidence that savers have in the system. The slightest sign of trouble can lead to panic and push savers into withdrawing their funds from these institutions. Banking crises have repercussions in the real sector and are likely to impede economic growth. Thus, if an efficient banking sector can produce positive externalities and generate, or at least support, growth, an ailing banking sector can bring negative externalities to the rest of the economy.

Nearly all the crises that occurred during the last decade came from the emerging countries. One of the possible solutions to limit banking instability, as widely discussed today, is to improve the regulation of the banking sector in developing countries. Is this normative regulation, supported by a group of measures concerning supervision and control appropriate to deal with the mechanisms of crises (as in the Basel Accord, for example)? Is it suited to the economic and financial structures of emerging countries?

In order to answer these questions, we will first analyze the causes of the instability of the banking systems in Latin America. Then we will examine the framework of the Basel Accord to see whether it is applicable to the Latin American banking systems in order to limit their instability. We will particularly insist on the Basle II implementation impact concerning capital adequacy ratio (CAR), prudential supervision and market discipline.

II. CAUSES OF INSTABILITY IN THE BANKING SYSTEMS IN LATIN AMERICA

Banking crises are complex and different from one another. There is a lot of literature on this subject that tends to make distinctions between macro- and microeconomic causes. A number of researchers have worked on this distinction in order to find "predicative" indicators of crises; Caprio (1998), Demirguc-Kunt and Detragiache (1998), Evans et al. …

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