Financial Regulation in Argentina
At the end of 1980’s, the banking system in Argentina was regulated by the 1977’ Banking Law. Argentina confronted with the highest levels of devaluation of currency (~60000%) and inflation (~50000%) in history. The financial system was virtually destroyed, and immediate changes were needed. In order to stop the hyperinflation and to reestablish the macroeconomic stability the government of Argentina decided to impose the currency board regime starting from the 1st of April 1991, enshrined by the Convertibility Law. The aim of the currency board was to ensure the hard peg against the US dollar: the Argentinean peso was pegged one for one to the US dollar.
Every change in regulation has immediate and long-term consequences. In the short run, only positive consequences can be identified, among which the seize of hyperinflation. The hard peg restored the credibility of market participants in Argentina’s economy. This is an evidence of the presence of market discipline in the regulatory system of Argentina. Regarding the long-term effects, many analysts consider that the financial crisis from 2001 was partly generated by the policies conducted by the currency board. The currency board was the right institution under the early 1990’s, but it was inefficient under the circumstances of the more developed Argentina after Tequila crisis.
The reason why currency board failed in early 2000’s is that de jure it was an institution, which enhanced market discipline, but de facto it exceeded its functions. In a market-based system, the Central Bank’s function of the lender of last resort must be limited, which also happened in Argentina. But the currency board could undertake this function. There is evidence that, during Tequila crisis of 1995, it extended funds to illiquid commercial banks. Another violation of the market based regulatory system is that the currency board was initially allowed to hold only 66.6% of its assets in true foreign reserves, the rest being backed by government bonds. Meanwhile, the correct practice says that currency board’s assets should be backed in 100% by foreign reserves.
An important regulatory innovation, following the crisis from 1991, was the enactment in 1992 of the New Charter of the Central Bank. The New Charter is considered as the beginning of market based regulatory system in Argentina because it allowed the independence of the Central Bank for the first time after its creation since 1936.
Argentina introduced capital requirements for credit risks, which implies that the interest rate for loans represents a signal for the degree of risks the institution is facing. An increase in interest rate signifies an increase of risks; thus capital requirements for credit risks increase proportionately with the interest rate. From 1992 to 1995 the assets at risk increased from 9.5% to 11.5%. Capital requirements were tightened during and after the Mexican crisis. High reserve requirements were also considered a tool for liquidity risks. Despite the fact that capital requirements existing in Argentina in the mid 90’s were tighter than the ones stipulated in the Basel Accord, it did not help the country during the run on banks in the early 2000’s. This implies that a market-based regulatory system is not a guarantee against crisis. After the Tequila crisis important changes were made for capital requirements. The reserve requirements were replaced with a liquidity requirement as to create reserves as protection against the liquidity risk. In accordance with these new regulations all categories of liabilities were considered for the calculation of the liquidity requirement and only deposit liabilities were taken into account for reserve requirements. Liquidity requirements were calculated depending on the interest rate for short-term dollar investments.
In addition to capital requirements, Argentina tried to issue subordinated debt as a fraction of the total assets but it was never able to apply this kind of regulations. In accordance with the BASIC regulatory system the banks in Argentina had to issue a subordinated liability for some 2% of their deposits each year. Because banks must issue debt on the market, this must provide information about the issuer to both debtors and supervisor mainly through price signals. This regulation was passed in 1996 to be implemented in 1998 but because of the regional financial crises it was never applied. The critics of the subordinated debt as a mechanism for market discipline uses the argument that a developed market for this category of debt is missing in emerging economies. Generally the secondary market for the subordinated debt is relatively under-developed even in successful economies. At the same time economists argue that a developed market for this category of debt is not really necessary. The aim of the subordinated debt is to give signals to the market about the risk of a financial institution in particular and of the financial system in general. If the government will force the financial entities to make frequent issues of short term subordinated debt then there would be a continuous flow of these instruments on the market, creating a good information environment for the market. In this way it would be no need to have a secondary market for the subordinated debt because the primary market will provide all the necessary information.
The list of improvements of the banking regulations targeting to establish a market discipline continued with the creation of a database for the main debtors of the financial system. The main debtors were considered those entities, which have loans exceeding USD 200,000. The more information the market has about the financial system the better it can monitor the risks and the evolution of the financial system. Market monitoring is a crucial factor in a market-based regulatory system. The availability of the debt databases is a proof of the positive evolution of regulatory changes in Argentina.
If the market will identify an increase in the risk then it will react by making its participants withdraw their deposits. Because of the high risks there will be no gains on deposits and the optimal solution for depositors under higher perceived risks is to withdraw their deposits. This depositor behavior has a contagion effect and can determine the run on banks. This is one of the reasons that explain the imposition of the safety net. In the early 1990’s deposit insurance was abolished being reintroduced later in May 1995 as a reaction to Tequila crisis. The mechanism of insuring deposits was working through the enterprise Sedesa S.A. financed by the government. Initially this institution had the purpose to compensate the customers of banks under liquidation. From one standpoint this measure had the aim to increase the trust of depositors in the financial system, and from the other it creates an over-regulation of the system limiting the market principles. At the same time, if depositors do not agree on the risk that the financial institution is facing, then there would be no runs on banks and the market will reach a new equilibrium point at the level characterized by lower deposits and higher interest rates. Thus, from this perspective, the safety net is not likely to have a strong argumentation and indeed has effects only to limit the market principles of bank regulation. Higher safety net separates market participants from the risk they are subject to. A safety net acts as a lender of last resort for financial institutions and in this way both the market and the financial institutions a prone to undertake higher risks than they would in its absence.
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[...] Financial Regulation in ArgentinaThe list of improvements of the banking regulations targeting to establish a market discipline continued with the creation of a database for the main debtors of the financial system. The main debtors were considered those entities, … [...]
[...] Financial Regulation in ArgentinaThe list of improvements of the banking regulations targeting to establish a market discipline continued with the creation of a database for the main debtors of the financial system. The main debtors were considered those entities, … [...]