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Banking upturn

Costly and recurrent banking crises have been a common denominator in Latin America during the past decades, so understanding their causes and learning how to prevent or mitigate them should be a priority task. Several IDB economists introduced recent studies during a 3-day workshop at the Bank’s headquarters in Washington, D.C.

A successful solution to banking crises should help stop their recurrence, according to Liliana Rojas-Suárez, who suggested three principles to achieve this. The first one, and hardest to accomplish, is a strong political will to allocate non-inflationary sources of funds such as the local regular budget and/or long-term funds from multilateral organizations to restructure banks. The second one calls for ensuring that those who benefited the most from the banking business when it was thriving, such as bank stockholders and delinquent borrowers, share the cost of bank restructuring. And the third principle calls for prompt action to minimize the fiscal cost of the crisis, designing a restructuring program that distinguishes banks by quality and setting in place schemes to bring the banking system back to solvency.

There are also three ideal conditions to effectively apply these principles: available funding to close down insolvent institutions or restructure banks, existence of markets to sell banks in trouble and their assets, and regulatory and supervisory independence to use adequate tools for bank restructuring.

In her study, Rojas-Suárez found that lack of funding, capital market shallowness and inadequate institutions have often resulted in higher fiscal costs of banking crises in Latin America. In every crisis, Latin America loses access to international capital markets, a situation exacerbated by the lack of secondary assets markets and lack of regulatory independence.

However, there are examples in the region of effective solutions to banking crises. Rojas-Suárez reports successes in Chile in 1984, Argentina in 1995 and Mexico in 1999. In all three cases, restructuring programs implemented all three principles.

In Chile, the authority implemented a comprehensive program for reconstructing the financial system. All three principles were taken into account simultaneously as prudential supervisory procedures were being sharply improved—including an explicit and limited deposit insurance scheme. Each principle also was implemented individually or combined within the reconstructing strategy. A large number of banks were closed and others sold to new owners who provided fresh capital, an action that adheres to principles 2 and 3.

There is no single optimal method of crisis solution, as each depends on a country’s macroeconomic environment and regulatory framework. But even under the most severe constraints, Rojas-Suárez concluded, restructuring programs can be successful if the authorities adhere to the three basic principles.

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