Alejandro Izquierdo

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Alejandro Izquierdo Andrew Powell Research
Department, IADB
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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

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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

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Credit Depth in Latin America
Note Simple average within regions. Mean Value
for the 1990s. Source World Bank data.
In Latin America, credit is scarce ...
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Credit Depth in Latin America
... especially in continental Latin America, even
controlling for the level of development
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Interest Rate Margin
Note Simple average within regions. Mean Value
for the 1990s. Source IMF data.
Credit in Latin America is costly.
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Interest Rate Margin
Low financial development is associated with high
spreads.
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Credit Volatility
And credit is also highly volatile
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Credit Volatility
...credit volatility is related with an
underdeveloped financial sector.
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Recurring Banking Crises
LAC is the region of the world with the highest
banking crisis recurrence
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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.

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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

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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

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Crisis and Volatility

• The volatility of the banking sector reflects a
  history of macroeconomic imbalances

In many countries dollarization is high ...
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Crisis and Volatility
... as well as public sector debt holdings.
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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

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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

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Sudden Stops
Emerging Asia of GDP
Indonesia 14.9
Korea 8.5
Philippines 32.0
Malaysia 11.9
Thailand 27.4

LAC-7 of GDP
Argentina 19.5
Brazil 7.0
Chile 4.0
Colombia 3.5
Mexico 12.4
Peru 21.2
Venezuela 0.25

• 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

Source Calvo, Izquierdo and Mejia (2007) and own
calculations.
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Twin Crises
This is highly relevant considering that sudden
stops and banking crises are another set of twins
(75 in dollarized countries)
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Balance Sheets
Abrupt changes in relative prices lead to
governments and non tradable firms
bankruptcies.
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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

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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)

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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

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Regulation and Supervision

• Regulation and supervision have been weak in
  Latin America.
• However, the situation is improving.

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Low Compliance withBasel Core Principles
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Selected Countries Improvements in BCP Compliance
Source IMF-World Bank Financial Sector
Assessment Program, Presentation A. de la Torre,
WB
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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

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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

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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.

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Market DisciplineBasel II Do the Pillars
Balance?
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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

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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.

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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

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The Role of Institutions Weak Creditor Rights
in LAC
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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.

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The Role of Institutions Creditor Rights
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The Role of Institutions Creditor Rights
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The Role of Institutions Creditor Rights
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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

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Banking System Structure Consolidation

• Following the banking crises of the 1980s and
  1990s, 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.

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Banking System StructureThe 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.

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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

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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 SMEs.
• Has made credit less vulnerable to liquidity
  shocks, but potentially more vulnerable to
  productivity shocks
• Raises difficult questions regarding supervision

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Banking System Structure Public Banking

• Public banks have reduced their participation in
  LAC through both sale and competition as private
  banks have grown faster

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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.

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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

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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

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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.

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Policy Agenda

• Define the governments 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.

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Alejandro Izquierdo Andrew Powell Research
Department, IADB