Building Effective Banking Systems in Latin America and the Caribbean: Tactics and Strategies
By E. Gerald Corrigan (04/97, IFM-107, En, Es) See also Infrastructure and Financial Markets
Over the past ten years, many countries, in all stages of economic development, have experienced major problems within individual banking institutions or entire banking systems. While there are many reasons for these developments, and while those reasons vary from country to country, several common denominators have been present in virtually all such episodes. Among those are the following:
- rapid changes in the macroeconomic and macro-financial environment,
- inadequate internal controls and procedures, together with lapses in official supervision or poorly developed official supervisory policies and practice, and
- concentrated patterns of credit or market risk exposure.
In almost all cases, the proximate cause of the banking sector problems can be traced to large credit losses. This has been true in highly developed countries with mature systems of banking supervision and regulation such as the United States and Japan, as well as developing countries with relatively untested systems of banking supervision such as Mexico, Brazil and Argentina.
As will be developed further in this paper, this experience clearly suggests that even well-developed and mature systems of banking supervision alone do not provide assurances that severe banking problems can be avoided.
The direct and indirect costs of banking sector crises have been astonishingly
high. Such costs are reflected in several ways, including:
- Direct Fiscal Costs. Even though countries have used a variety of devices to spread costs over a long period of time, direct fiscal costs ranging from 5% to 10% of GDP have not been uncommon.
- Lost Domestic Savings. Literally tens, if not hundreds, of billions of dollars of precious domestic savings have been poured into the black hole of bad credits in a setting in which such savings are in very short supply. This is especially troubling in Latin America and the Caribbean, where the presence of low domestic savings rates is perhaps the largest single barrier to sustained high rates of economic growth.
- Reduced Growth. The paralyzing effects of banking crises on both lenders and borrowers have severely restrained GDP growth.
- Adverse Incentives. Moral hazard problems growing out of decisions by governments to protect depositors and other creditors have been considerable.
- Erosion of Public Confidence. A particularly insidious cost imposed by banking crises is the erosion of public and political confidence in the banking system. This erosion of confidence can stand in the way of precisely the kinds of reforms that are needed to remedy the prevailing problems and build the progressive banking and financial systems that are so vital to the long-run success of the countries in question.
In many emerging markets countries, including Argentina, Brazil and Mexico, banking sector problems have been especially acute despite the presence of very wide net interest margins. On the surface, these wide margins should provide ample cash flow to absorb credit losses, but in fact, not only have such interest margins not been remotely adequate to cushion credit losses, they have also imposed extraordinarily heavy interest cost burdens on many borrowers.
While the symptoms and costs of banking sector problems are widely recognized, the magnitude of the remedial task is often significantly underestimated. To put that task in some perspective, the following three observations should be kept in mind. First, the acute and costly nature of the problem in most developing countries primarily reflects a host of historical institutional weaknesses that severely complicate the relationships between creditors and debtors. The resulting absence of a "credit culture" almost ensures a high incidence of credit problems, especially in the face of volatile economic and financial conditions. Second, under the best of circumstances, including solid economic performance, it will take a number of years to remedy these institutional problems, even as largely successful stopgap and damage control programs have been put in place. Third, building progressive and profitable banking systems in these countries will entail a mix of short-term and longer-term initiatives on the part of the banks, the authorities and the governments at large, as well as enlightened support and leadership from the international community, including the IMF, the World Bank and the regional development banks.
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Last updated: 05/08/07
