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  • 1. Alejandro Izquierdo Andrew Powell Research Department, IADB
  • 2. Unlocking Credit
    • Stylized Facts
    • Crisis and Volatility
    • Sudden Stops and Banking Crises
    • Crisis Resolution
    • Crisis Prevention
    • Exit Rules
    • Creditor Rights
    • Industrial Structure
    • The Policy Agenda
  • 3. Unlocking Credit
    • Stylized Facts
    • Crisis and Volatility
    • Sudden Stops and Banking Crises
    • Crisis Resolution
    • Crisis Prevention
    • Exit Rules
    • Creditor Rights
    • Industrial Structure
    • The Policy Agenda
  • 4. Credit Depth in Latin America In Latin America, credit is scarce ... Note: Simple average within regions. Mean Value for the 1990s. Source : World Bank data.
  • 5. Credit Depth in Latin America ... especially in continental Latin America, even controlling for the level of development
  • 6. Interest Rate Margin Credit in Latin America is costly. Note: Simple average within regions. Mean Value for the 1990s. Source : IMF data.
  • 7. Interest Rate Margin Low financial development is associated with high spreads.
  • 8. Credit Volatility And credit is also highly volatile
  • 9. Credit Volatility ...credit volatility is related with an underdeveloped financial sector.
  • 10. Recurring Banking Crises LAC is the region of the world with the highest banking crisis recurrence
  • 11. Banking Credit in Latin America
    • No wonder, lack of credit is firms’ concern number 1
    • Moreover, access to credit is restricted for certain groups, in particular SMEs
    • These characteristics of credit limit economic performance and poverty alleviation.
  • 12. This Report ...
    • Explores these characteristics of banking credit from three perspectives
      • The effects of crises , their resolution and prevention
      • The impact of changes in the structure of the banking sector
      • The role played by the institutions supporting credit markets
  • 13. Unlocking Credit
    • Stylized Facts
    • Crisis and Volatility
    • Sudden Stops and Banking Crises
    • Crisis Resolution
    • Crisis Prevention
    • Exit Rules
    • Creditor Rights
    • Industrial Structure
    • The Policy Agenda
  • 14. Crisis and Volatility
    • The volatility of the banking sector reflects a history of macroeconomic imbalances
    In many countries dollarization is high ...
  • 15. Crisis and Volatility ... as well as public sector debt holdings.
  • 16. Unlocking Credit
    • Stylized Facts
    • Crisis and Volatility
    • Sudden Stops and Banking Crises
    • Crisis Resolution
    • Crisis Prevention
    • Exit Rules
    • Creditor Rights
    • Industrial Structure
    • The Policy Agenda
  • 17. Sudden Stops
    • Despite contagion in capital markets, the probability of a sudden stop depends on the interaction between the supply of tradable goods (a proxy for potential changes in relative prices) and the degree of dollarization
  • 18. Sudden Stops Source: Calvo, Izquierdo and Mejia (2007) and own calculations.
    • Both the size of the banking system as well as the dollar share of credit are key in determining the burden of dollarization (% of GDP)
    • This type of measures brings Asia “closer” to Latin America
    12.4 % Mexico 21.2 % Peru 11.9% Malaysia 4.0 % Chile 7.0 % Brazil 3.5 % Colombia 0.25 % Venezuela 19.5 % Argentina % of GDP LAC-7 27.4 % Thailand 32.0 % Philippines 8.5 % Korea 14.9 % Indonesia % of GDP Emerging Asia
  • 19.  
  • 20. Twin Crises This is highly relevant considering that sudden stops and banking crises are another set of twins (75% in dollarized countries)
  • 21. Balance Sheets Abrupt changes in relative prices lead to government’s and non tradable firm’s bankruptcies.
  • 22. Unlocking Credit
    • Stylized Facts
    • Crisis and Volatility
    • Sudden Stops and Banking Crises
    • Crisis Resolution
    • Crisis Prevention
    • Exit Rules
    • Creditor Rights
    • Industrial Structure
    • The Policy Agenda
  • 23. Crisis Resolution: Basic Principles
    • Principles
    • Allocation of non-inflationary public funds
    • Ensure risk takers bear a large fraction of restructuring costs
    • Avoid gambling for resurrection
    • Actions
    • Reserve accumulation or foreign packages
    • Discrimination among banks and depositors
    • Resolution of insolvent banks (private & public)
  • 24. Unlocking Credit
    • Stylized Facts
    • Crisis and Volatility
    • Sudden Stops and Banking Crises
    • Crisis Resolution
    • Crisis Prevention
    • Exit Rules
    • Creditor Rights
    • Industrial Structure
    • The Policy Agenda
  • 25. Regulation and Supervision
    • Regulation and supervision have been weak in Latin America.
    • However, the situation is improving….
  • 26. Low Compliance with Basel Core Principles
  • 27. Source: IMF-World Bank Financial Sector Assessment Program, Presentation A. de la Torre, WB Selected Countries: Improvements in BCP Compliance
  • 28. Basel II Implementation (cont)
    • Some countries fall between two stools
      • Standardized approach does little to link capital to risk
      • More advanced Internal Rating Based Approach (IRB) approach give too much autonomy to banks and are difficult to supervise
    • I have suggested an intermediate Centralized Rating Based (CRB) Approach
      • See Powell (2004) “Sailing Through the Sea of Standards” World Bank Policy Research Working Paper Series 3387
      • Majnoni and Powell (2005) Bank Capital and Loan-Loss Reserves under Basel II: Implications for Latin America Economia p105-149
  • 29. Basel II Implementation (cont)
    • Is Basel II a standard for 100 banks across G10 or for all banks in each G100?
    • The US is keeping most banks on Basel I and may allow a handful to adopt the most advanced approaches but still uncertain…
    • Some countries in LAC are staying with Basel I for now, but even here there are adaptations…
    • China has said Basel I + = Basel I plus Operational Risk
    • Some may allow some banks aspects of Basel II but there is a danger that the essence of a standard will be lost as countries adapt different elements
  • 30. Market Discipline
    • Market discipline is alive in Latin America
      • Martinez Peria and Schmukler (2001): depositors run weak banks and demand higher interest rates.
      • Galindo, Loboguerrero and Powell (2005): ….and banks react, shrinking assets and/or increasing capital
    • Is the best/only form of discipline for banks?
      • Berth, Caprio and Levine (2006) “Rethinking Banking Regulation: When Angels Govern…”
    • Need to ensure those that take risks bear costs…
    • Basel II does not go far enough….
  • 31. Market Discipline Basel II: Do the Pillars Balance?
  • 32. Unlocking Credit
    • Stylized Facts
    • Crisis and Volatility
    • Sudden Stops and Banking Crises
    • Crisis Resolution
    • Crisis Prevention
    • Exit Rules
    • Creditor Rights
    • Industrial Structure
    • The Policy Agenda
  • 33. Bank Exit Rules
    • Latin America has been introducing new exit rules for banks
    • In the wake of the 1995 “Tequila crisis”, Argentina adopted a “least cost” resolution process for the deposit insurance fund.
    • And the possibility of creating a “good bank” to be sold and a “bad bank” to be liquidated
    • This idea has been catching on in several countries, to resolve problem banks quickly and avoid costly judicial procedures.
  • 34. Unlocking Credit
    • Stylized Facts
    • Crisis and Volatility
    • Sudden Stops and Banking Crises
    • Crisis Resolution
    • Crisis Prevention
    • Exit Rules
    • Creditor Rights
    • Industrial Structure
    • The Policy Agenda
  • 35. The Role of Institutions: Weak Creditor Rights in LAC
  • 36. The Role of Institutions: Creditor Rights
    • Creditor rights in LAC are weak .
      • Regulations in favor of debtors during bankruptcy.
      • Courts are inefficient (bankruptcy procedure, 4 years)
      • Obstacles to recover collateral
    • Improving creditor rights can:
      • increase financial depth (by 15% of GDP)
      • reduce credit volatility by nearly half...
      • and increase access to credit by SMEs by at least 15%.
    • However, reform is difficult to implement .
    • Banks are seen as bad, but weak creditor rights implies no credit market hurting good borrowers.
  • 37. The Role of Institutions: Creditor Rights
  • 38. The Role of Institutions: Creditor Rights
  • 39. The Role of Institutions: Creditor Rights
  • 40. Unlocking Credit
    • Stylized Facts
    • Crisis and Volatility
    • Sudden Stops and Banking Crises
    • Crisis Resolution
    • Crisis Prevention
    • Exit Rules
    • Creditor Rights
    • Industrial Structure
    • The Policy Agenda
  • 41. Banking System Structure: Consolidation
    • Following the banking crises of the 1980’s and 1990’s, and financial liberalization, there has been massive consolidation in the banking industry
    • But concentration has not reduced competition.
    • Higher concentration reduces NIM and overhead costs.
    • Concentration has reduced credit volatility, increased access to credit, and eased supervision.
  • 42. Banking System Structure: The Role of Information
    • Normally would talk about improving credit information in terms of improving credit access or reducing non performing loans.
    • But information plays a critical part in determining the industrial structure of banks too.
    • Latin American financial systems are characterized by poor information flows, high swtiching costs and local monopoly power, this implies a structure of many, smaller banks with high overheads.
    • As information improves, competition is enhanced and overheads must decline, concentration and lower spreads follow.
  • 43. Banking System Structure: Foreign Banks
      • There has been a drastic change in bank ownership in favor of foreign banks . More than 50% foreign owenership in Argentina, Chile, Mexico and Peru
  • 44. Banking System Structure: Foreign Banks
    • Foreign banking has:
      • Increased efficiency (lower interest rate margins)
      • Had mixed results in other areas:
        • There is controversy as to whether credit access has increased, particularly to SME’s.
        • Has made credit less vulnerable to liquidity shocks , but potentially more vulnerable to productivity shocks
        • Raises difficult questions regarding supervision
  • 45. Banking System Structure: Public Banking
    • Public banks have reduced their participation in LAC through both sale and competition as private banks have grown faster
  • 46. Banking System Structure: Public Banking
    • But public banking has remains an important share of total banking:
      • Public banks enjoy strong political support ...
      • They appear to be inefficient (high operating costs)
      • And have low portfolio quality and
      • Have low deposit rates due to implicit government guarantee and implying a hidden fiscal liability .
    • Performance should be measured against their mandate, but few countries are explicit about what that is and fewer have targets and evaluations.
    • Tellingly they do not appear to lend more to SMEs nor to sectors that would accord with the “social mandate”.
  • 47. Unlocking Credit
    • Stylized Facts
    • Crisis and Volatility
    • Sudden Stops and Banking Crises
    • Crisis Resolution
    • Crisis Prevention
    • Exit Rules
    • Creditor Rights
    • Industrial Structure
    • The Policy Agenda
  • 48. Policy Agenda
    • Plan ahead to avoid crises
      • Enhanced regulation and supervision, especially in the upswing, lean against the wind.
      • Control credit booms and asset price bubbles.
      • Self insurance or programs with multilaterals to reduce the probability of a Sudden Stop or reduce impact.
      • Reduce risks with incentives to dedollarize and the creation of hedging markets.
      • Dedollarization is not easy requires a concerted approach with monetary policy and prudential regulation
  • 49. Policy Agenda
    • Pay for your sins:
      • Crisis resolution processes must ensure that the parties that took higher risks bear the costs.
      • Explicit, limited deposit insurance and appropriate exit rules for banks.
    • Play safe:
      • Financial regulation needs to appropriately measure credit risks (including the treatment of dollar loans and government debt) to determine safe levels of capital- adequacy ratios and provisions .
      • Supervision has improved but Basel II adoption poses many challenges for region.
      • Foreign Banks can play an important role, must consider their supervision very carefully.
  • 50. Policy Agenda
    • Define the government’s business :
      • The role of government in commercial banking needs to be defined by specifying the objectives of public banks and evaluating whether they are met in a cost effective manner .
    • Design the right financial environment :
      • Increasing creditor protection requires a serious reform of secured transaction laws and enhancing judicial efficiency. The creation of specialized courts to deal with collateral claims may play a role.
  • 51. Alejandro Izquierdo Andrew Powell Research Department, IADB