Basel II: Systemic Consequences – A Study of its Implementation in the Argentinean Financial System.

Alejandro Vanoli (*)

(*) Professor of International Economics at the University of Buenos Aires’ School of Economic Sciences. Currently, Vice-President of the Argentinean Securities & Exchange Commission. Former Economic Advisor at the Argentinean Central Bank. This paper counted on the collaboration of the following economists: Augusto Magliano (Jr.) and Julieta Delgado. The author would like to thank the valuable commentaries made by Arturo O’ Connell and Augusto Magliano, María de las Victorias Martínez collaborated in the assembling and translation.The author assumes exclusive responsibility for the contents of this paper which in any way pretends to compromise the opinion of neither the Argentinean Government, the Argentinean Central Bank, nor the Argentinean Securities & Exchange Commission.

1

Abstract

Globalization, as well as rapid changes in the structure of financial firms, together with the development of new financial instruments during the Nineties contributed to the launching of new kinds of risk and their prompt transmission. This situation gave rise to the discussion on new topics related to banking supervision and regulation.

During the past years, the consecutive global financial crises have proved that the embracing of Basel I did not generate, by itself, stronger financial systems. As a matter of fact, in Argentina, where higher and stricter standards were adopted, a severe financial crisis was suffered, which –let aside other economic inconsistencies- was not free from the consequences produced by that prudential regulation.

The Basel Committee recognized that Basel I had ceased being adequate to define capital adequacy in this new context.

The New Accord (Basel II) designed by the representatives of the G-10 monetary authorities will provide benefits, especially to Developed Countries’ (DC) major banks internationally active. On the other hand, the ‘minimum-capital’ requirement standard tackles not only technical objections, but critics in terms of the complexity of its implementation.

Argentina diminished and/or suspended certain regulatory requirements right after the crisis, and could gradually redress its financial system. In December, 2006 the Argentinean Central Bank (BCRA) announced the adoption of the simplified standardized approach to credit risk. This decision turns out to be appropriate since this method is more in agreement with the Less-Developed Countries´ (LDC) financial systems than the IRB approach.

It has been pointed out that Basel II lacks a comprehensive approach to risk. Besides, only the bigger financial institutions will profit from this new regime, since they will be able to afford the high costs of implementation together with a lack of high-skilled human resources in order to comply with the more advanced standards.

In addition, the New Accord would accentuate the pro-cyclicality in the credit sequence; induce a reduction in the capital flow towards LDC in terms and monetary issues, which would as well increase volatility, thus turning financial systems more unstable. It is not yet well precised the effect that it would spawn on the credit supply towards SMEs. Therefore, Basel II probably would not only be unsuitable to prevent the causes that kick-off financial crisis, but it may also nourish them.

Introduction

This paper analyses the reasons that gave birth to the creation of the international standard on capital adequacy for banks. It includes general remarks on Basel I policy, as well as an account on the major features of the regulation and comments on its brisk diffusion.

The following section presents the implications and causes of the application of Basel I criteria in Argentina during the early Nineties. It explains the evolution of that regulation lined up to the convertibility model, the additional prudential regulation –a.k.a. ‘Basel Plus’- arisen after the Tequila crisis; its effects on the national financial system: concentration and foreign take-over of national banks, credit rationing for SMEs, currency mismatches, high exposure to the public sector, etc.

2

Next, an assessment on the causes that drove the Argentinean economy to the 2001 devaluation, as well as an account for the financial system crisis (‘corralito’, ‘corralón’, ‘default’, ‘pesificación’) and the drop out of convertibility model; followed by the impact of the new economic strategy and the changes in credit regulation, as well as new prudential rules bound to reorganize the Argentinean financial system. It also analyses the forbearance policy applied by the BCRA vis á vis the contrasted viewpoint of international financial institutions (IFIs).

In the subsequent section, the background that lead to the formulation of Basel II; its general features; the reasons for the LDC markets’ adherence to Basel II; its improvements; the different approaches in terms of credit risk and operational risk; its differences from Basel I, along with the critics to the New Accord: pro-cyclicality, risk and diversification, IRB competitive advantage vs. Standardized Approach, credit to SMEs.

Subsequently, the implementation of Basel II in Argentina is analyzed, focusing on the BCRA’s decision to apply the simplified standardized approach as from 2010, the standard adoption road map, its benefits, costs and risks.

The paper concludes with a series of remarks on the limitations of Basel II to prevent international crisis and to promote stable financial systems tuned up to promote development. Finally, it explores the implications for Argentina.

BASEL I: THE CREATION OF THE INTERNATIONAL STANDARD ON CAPITAL ADEQUACY FOR BANKS AND ITS FAST DISSEMINATION.

Background

The concern about unifying the minimum capital regulations for internationally active banks present among different countries, in the attempt to balance out the current competitive conditions at that time, lead the US Federal Reserve to carry out a proposal for the establishment of capital requirements based on risk assets, towards the end of the Eighties. In particular, US bank regulatory authorities observed with apprehension that American financial entities were being displaced –in the international spectrum- by the aggressive expansion of their fellow Japanese competitors, fact attributed to Japanese slack capital adequacy regulation, which allowed them for greater leveraged operation. The concern was common to other occidental bank authorities.

For these reasons, the US Federal Reserve tendered a proposal for establishing capital requirements based on risk assets1. Anon, in 1987 the U.S. together with the U.K. made some bilateral progress agreeing on common definitions in terms of capital and risk categories used for the classification of risk assets, as well as the capital ratio to be established. Finally, in 1988 the Bank for International Settlements’ Basel Committee on Banking Supervision (BIS) chaired by a U.K. representative, released a comprehensive proposal on the matter.

Basel I - Main Features

In July, 1988 the BIS together with the G-10 central banks agreed to establish a common system of bank capital measurement, as well as to apply a minimum capital ratio to those institutions: 8% over risk-weighted assets (this value used to be similar to the assets/net worth ratio of American banks, which is why they were not required to make a special capitalization effort).

Consequently, assets were classified in five categories according to the inherent risk of each one. Thus the considered assets rated as implying a null risk (currency, credits to governments of the OECD countries)

1 Technically, minimum capital requirements are set up to grant the financial entities’ adequacy and reliability to face unexpected losses. Provisions must be constituted in order to cope with statistically forecasted losses (expected losses).

3

did not require capital exigencies. Afterwards, categories requiring 10%, 20%, 50% and 100% of the assets were counted.

On the other hand, capital resources were divided in two categories: Core Capital and Supplementary Capital. The first one made up of countable capital and reserves which must constitute a minimum of 50% of the net worth requirement. The Supplementary one is satisfied by off-balance sheet items (non-published reserves, general asset revaluations, provisions against losses as well as medium and long term subordinated debt).

Concisely, the fundamental innovation was given by the entailment of minimum net worth with the risk inherent to the different classes of assets that each bank had in its loan and investment portfolio.

BASEL STANDARD DISSEMINATION

General Issues

The rapid international dissemination of Basel’s adequacy standard for banks responded to different reasons. In the case of developed countries (DC), although the initiative was impelled by the U.S.A., its acceptance responded to a consensus obtained at the BIS. In LDC however, the adoption of Basel I was imposed by IFIs as a condition of their assistance, policy that was reinforced in Latin America with the suggestions contained in the so called "Washington Consensus", as integrating the neo-liberal reforms pack. Under these circumstances, the quick incorporation of Basel standards by Argentina is explained by a third reason, which will be specified further on.

Argentina

By the end of the Eighties, the Argentinean financial system showed great difficulties when it came to fulfill the functions of savings receptor and fund allocation for consumption and investment. This flaw can be explained by the high levels of inflation that Argentinean economy experienced which caused a sound flight of capitals, generating -this way- economic demonetization.

Finally, hyperinflationary processes with serious economic and institutional consequences burst. Inflation increased explosively reaching an average annual rate of 2,600% after 1989 and 1990. The hyperinflationary explosion between the months of May and August, 1989 produced a public finances’ collapse leaving a deteriorated fiscal situation, an increasing public indebtedness and minimum levels of international reserves, causing the early hand-over of power by the retiring government to the newly elected one. The new administration, strongly biased by neo-liberal doctrine, imposed a series of reforms in an attempt to transform the Argentinean economy into a market economy that would help overcome the lost decade of the Eighties. As it was mentioned above, the adopted measures strictly followed the recommendations specified by Williamson at the "Washington Consensus".

Particularly deep changes took place in the monetary arena: foreign trade liberalization and privatizations of previously state-owned companies providing public services; policies tending to liberalize the flow of foreign capitals2 were necessary to maintain a fixed exchange rate regime with a Balance of Payments’ current account deficit and with increasing fiscal deficit3, put down to the privatization -in 1994- of the national social security system4, the solid increase of investment income (financial services)5, originated

2 Between 1991 and 2000 Argentina received USS 115.000 million as credits to both the public and private sector, together with the purchasing of local assets.3 56% of capitals entered during 1991-2000, were asigned to financing the fiscal deficit. In 1999 the consolidated nation-provinces deficit was 4% of the GDP (USS 11,000 million). 4 The privatization of the social security system implied that the State maintained the payment of retirement salaries whereas ceased perceiving retirement contributions, with the consequent income decrease. Six years later the private social securities companies (AFJP) collected $ 24,000 million, had that previous system been maintained, it would have reinforced public finances. 5 Between 1992 and 2000 the public sector made debt interest rate payments for 60,000 million dollars.

4

by strong external indebtedness and the drop in tax collection taking place from beginning of the recessive cycle in 1998.

Under this ideological framework, the stabilization strategy aimed at eliminating hyperinflation consisted in the adoption of the mentioned fixed exchange rate regime ("Convertibility Regime"). In this circumstances, the chosen road to revert severe system demonetization within the frame of the Convertibility Plan (which established by law the exchange equality between one Argentinean peso and one American dollar), was the indiscriminate liberalization of the Balance of Payments’ capital account. This step had the purpose of achieving greater financial depth, giving incentives to the free flow of international capitals and the return of national capitals, which would be risk safe of devaluations in local currency.

Moreover, indexing was prohibited in 1991, consistently with the stabilization policy aimed at restraining inflationary sequels, which is why it was necessary to redesign the financial system adequacy requirements, whose fundamental piece was minimum capital requirements. Given the preexisting inflationary scenario, until the sanction of the Convertibility Act, capital requirements were regularly adjusted by inflation6 with the consequent damages and distortions7. As opposed to this fragile situation, the BCRA was receptive to the suggestions of a sector of the national banks on the adoption of the set of standards established by the BIS in 1988.

THE APPLICATION OF BASEL I IN ARGENTINA

The adoption of Basel I in Argentina goes back to 1991 together with the coming into force of the Convertibility Regime. But it is appropriate noticing that in the Argentinean case the adequacy standards were more comprising and more demanding than the ones suggested by the international standard. More comprising since the estimation of minimum capitals for the unexpected losses was not only included, but it also added a strict regime of provisions for expected losses, and more demanding because the ratio capital/risk assets –after a while- turned out to be superior to the 8% promoted by the BIS (it went as far as 11,5%), together with the progressive establishment of additional net worth requirements. As well, BCRA complemented the adequacy standards, creating the Central Debtors Office and the Regime of Debtor Classification, from which provisions were constituted. Additionally, given the total liberalization of banking activity, they decided to improve and empower the prudential regime, having to face the new supervising problems.“Basel Plus”

So it was, that from 1993 and -with greater emphasis- after the "Tequila Crisis”, the BCRA adopted a series of measures tending to reinforce the system’s adequacy and liquidity shaping a regime known as Basel Plus.

The underlying explanation to the reinforcement of adequacy standards is that the 1991 Convertibility Act, restricted the BCRA’s possibility to act as the Lender of Last Resort, which implies currency emission, key element to guaranteeing stability in the financial system. This way, it was necessary to empower the financial system, exposed -to a great extent- to local economy fluctuations. In addition, being the Balance of Payments’ capital account liberalized, that situation could worsen by eventual changes in international capital flows. Simultaneously, given that the deposit guaranty regime had been suppressed, there existed reasons to try and diminish the risk of bankruptcy to which entities were exposed. In order to fulfill this objective, the banking policy was based on three principles:

Encouraging concentration in order to assure a greater net worth scope throughout the system.

6 Wholesale prices Index, general level. 7 Specially the smaller institutions were affected by the indexation of minimum capital requirements whereas the volume of their assets diminished in real terms, consequence of the demonetization induced by inflation, which generated a drop in leverage.

5

Favoring of national banks take-overs done by foreign firms by means of liberalizing the regime for the acquisition or installation of foreign banks, since it was hoped for that the Head Offices would replace the BCRA in its role of Lender of Last Resort, when needed to.

Demanding prudential regime. In this context, the prudential regime was designed, essentially,

as a function of Convertibility, not of the explicit financial system needs.

This way, absolute priority was granted to adequacy standards over any other type of regulation, neglecting other essential aspects (private sector foreign currency indebtedness constraints as well as public sector financing constraints).

Additionally, forward steps were taken towards partial privatization of supervision. The supervision policy was modified, decreasing the significance of financial firms in situ controls, while external audits, risk assessment companies as well as market risk evaluation gained importance.

As previously stated, successive additional reforms in adequacy standards were adopted as a result of the Tequila banking crisis suffered in 1995 which affected many Latin American countries.

Concerning the Argentinean case, the Tequila effect exposed the financial system’s acute weaknesses. Banking frenzy in Argentina caused a reduction of 18% of deposits in a five months period which produced banks liquidity problems, generating -in some cases- adequacy issues. This effect was observed mainly amongst the official province banks, wholesale banks and cooperative banks, which lost deposits were transferred to foreign institutions ("flight to quality").

Due to these liquidity problems, it became necessary the initiation of a series of reforms within the Basel Plus frame, in order to overcome the effects of the crisis, as well as to prevent them in the future. Then, reforms consisted in changes and adjustments to the Financial Organizations Act (introducing the organizations re-structuring regime8) and to the BCRA Charter Law.

As well, a system of guaranty insurance for private deposits was reinstated, mandatory for financial entities that had to integrate it with monthly contributions determined by the monetary authority on the basis of the average daily deposits balance. This insurance would manage by an Organization created for that purpose: Seguros de Depósitos S.A., (SEDESA) administered by the banks. Nevertheless, the resources assigned for SEDESA were insufficient. In 1998, when funds reached their peak, they did not represent more than 2% of the system total portfolio and were used up for the assistance to around 35 banks in crisis between 1995 and 1999, virtually left without funds since then (Frediani, 2002). As well, two fiduciary funds were created. One of them was to facilitate privatization of provincial banks and the other one was to attend in the reconstruction or merges between private banks suffering difficulties.

Regarding liquidity, minimum requirements were settled down (independently of minimum currency) which had to be made through the transfer of currencies to an account in a foreign bank (Deutsche Bank New York). This measure was justified by the need of reinforcement of banks’ credibility by means of safeguarding their reserves9. On the other hand, it was agreed that minimum currency had to be kept over deposits’ residual terms, which implied increasing the mandatory reserves with deposits’ maturity. In order to provide greater liquidity to the system in case of need, the BCRA established a program of swaps with 13 international banks, which could be activated when considered necessary. This program was later reinforced by a credit line from the World Bank and the IADB for USS 1,000 million10.

8 As a result of the crisis, soon after the process of mergers and acquisitions, the number of financial firms diminished from 205 to 156 in December, 1995. This way, the system was integrated by 22 public banks (of which 16 were official province banks and municipal), 105 private banks and 29 non-banking entities. 9 The constitution of reserve requirements outside national boundaries, lacked precedents in the international experience. 10 When in 2001 this agreement of swaps started to be applied, important practical implementation difficulties were pointed out. When the State declared itself in default in December of that year, the credit line had to be cancelled.

6

Also in the topic of supervision, standards of American banking supervising entities were adopted. Thus, new qualification methodologies were put into practice. As of 1995, banking supervision uses the CAMEL system by which it assesses each organization’s Capital, Assets, Management, Earnings and Liquidity, from 1 to 5, and then calculates the arithmetic average of these five aspects to express them as the qualification of a bank and also operates with system BASIC (Bonds, external Audit, Supervision, Information, and Credit Qualification). On the other hand, the supervising authority frequently inspected in situ, at least every 18 months and even more often in the case of banks suffering difficulties.

With reference to adequacy, the minimum capital requirement was increased gradually up to 11.5% on risk assets (January, 1995), whereas the coefficient of capital for illiquid assets was set at 12.5%. Also, additional net worth exigencies by market risk in 1996 were introduced in an attempt to compensate the fluctuations of banking assets with quotation, and by interest rate risk in 1999 (by maturity mismatches between assets and liabilities). In addition, the total capital requirement exigency could be greater when applying a correction factor determined by the entity’s qualification granted by the Supervising Authority (CAMEL factor) able to raise the net worth requirement up to 15% for worse rated entities and by another coefficient linked to the level of loan rates agreed upon by the entity herself (Risk Indicator or IR factor), aspect not included in the international standard. These measures lead -in the 2001, year in which the crisis burst- to the capital maintenance by Basel I international standard).

Albeit, the standards allowed banks to keep mismatches between the Argentinean peso and the American dollar, the indistinct integration of mandatory reserves and minimum liquidity requirements in one or the other currency. This situation brought about asymmetries amongst assets expressed in local currency to higher rates funded with liabilities expressed in American dollars, were a source of both nonliquidity and adequacy to the financial system, before the Convertibility landslide of the convertibility.

FINANCIAL POLICY AND BASEL PLUS’ ENFORCEMENT EFFECTS IN ARGENTINA

Effects on the Structure of the Financial System

On the one hand, being the ratio capital/risk assets so high, smaller entities were harmed, since a high volume of operations was necessary to reach -in the short term- in order to render them efficient. On the other hand, it must be noticed that high capital income attracted by the high yields were registered (high domestic interest rate) based on the fixed and appreciated exchange rate. This generated an abrupt growth in monetization and, consequently, in the system’s loan capacity, which generated an increase in the credit supply that was absorbed sharply by a demand, which had been repressed during the previous years. This situation was harnessed by the State’s introduction of greater liquidity, by increasingly financing its fiscal deficits via external debt11.

Banks’ difficulty to reach greater operative scale in relatively short terms (both to place loans without assuming excessive risks, as to gather the minimum capitals based on the forecasted growth for the medium term) stimulated the shareholders of some National Banks to sell their shares to foreign investors who, on the other hand, hoped to obtain higher yields in the local market (measured $ 1 = USS 1, by virtue of the convertibility) and to benefit from counting on with an installed distribution network. Between 1991 and 1999 assets increased up to an annual rate of 22%, which gives an idea of the capital contribution requirements during that same period (Bleger, 2000).

Additionally, the process of foreign take-over12 of banks was deliberately facilitated in order to compensate the weaknesses of the BCRA as a Lender of Last Resort -previously explained- and on the basis of the benefit that it would bring: greater access to international markets. Regulations for migrating foreign banks were permissible on the assumption that if the Head Offices did not assist their branches in the context of nonliquidity, they would undergo a reputation cost worldwide.

11 The national fiscal deficit during the years between 1991 and 2001 totalized USS 108,000 million (Frediani, 2002). 12 Chart 1 shows that in 1995 the total deposits in foreign banks was 17.1% of financial system deposits. In 2001 this proportion had increased, reaching 201%, including 51.4% of the total deposits in hardly six years.

7

Chart 1: Foreign Banking Take-over and Deposit Concentration After the Tequila Crisis

1995 2001 Variation %

Total Deposits in National Banks (%) 82,9 48,6 -41

Total Deposits in Foreign Banks (%) 17,1 51,4 201

Total Deposits in the 10 Major Banks (%) 59 74 25

Source: BCRA , SEFyC13.

As well, public banks were privatized in an attempt to eliminate a source of financing for provinces which had generally showed a high index of past-due loans14.

Effects on the System’s Vulnerability

In addition, the Argentinean regulatory regime caused many financial firms to prefer financing the public sector, which supposedly had no risks, offered high yield and regulatory-wise did not present minimum capital requirements, instead of financing the private sector (crowding-out). This, as well, operated as a perverse incentive for National Banks, since they could manage to achieve operative scale concentrating their loan capacity in public bonds, whereas they assumed an increasing default risk regarding national debt. Nevertheless, if the reached scale was such of considerable size, they had an implicit rescue insurance associated to the "too big to fail" assumption. This means, some banks decided to finance the public sector without taking into account the risk of default since they obtained scale, yield and at the same time they gained market share within the banking sector, reason why in the event of default, the BCRA rescue function would be fulfilled, being the latter forced to play a part as the monetary authority, preventing the fall of a great bank which could affect the rest of the financial system. On the other hand, it must be pointed out that in spite of the equivalence between the Argentinean peso and the American dollar, both loan and deposit operations (with the exception of current and savings accounts) were mainly dolarized. This phenomenon increased as a consequence of the measures adopted by the end of 200115.

Effects on Credit

The growth observed in the market share of foreign banks in the credit supply16, had adverse effects for SMEs domestic capitals, since they preferred to focus their financing towards companies presenting reduced risk, preferably foreign ones.

This credit rationing together with rate raises after the Tequila effect, as well as the unfavorable evolution of relative prices in tradable goods, had negative consequences, which go from the progressive worsening

13 Supervising Authority for Financial and Exchange Entities.14 The privatization of most public provincial banks who had been severely affected by the crisis and of Banco Hipotecario Nacional was achieved. However, Banco de la Nación Argentina, Banco Provincia de Buenos Aires, Banco de la Provincia de Córdoba and Banco Ciudad de Buenos Aires, among others, remained in hands of the State. 15 It is worth noting that although banks looked for balance between their assets and liabilities in foreign currency, this ended up being only an accounting illusion. What happened was that the majority of indebted economic agents -in dollars- did not generate their income in the same currency, which also applies to the public sector as a debtor. That is to say, the insolvency risks assumed by the banking system were increasing in case of Convertibility was to drop out. 16 Still, comments made at the CGFS workshops suggest that small and medium-sized enterprises (SMEs) often have difficulties in obtaining credit from foreign banks, which are more dependent on standardised credit evaluation. Consequently, lending to SMEs from foreign banks depends on the availability of reliable accounts, and transparent procedures for posting collateral and foreclosure (BIS Quarterly Review, December, 2005).

8

of credit history which finally excluded many companies of the possibility to access banking credit, to the increase of bankruptcy requests. Empirical evidence, in effect demonstrates that bank concentration processes as well as those of related to banks take-overs done by foreign firms tend to diminish the loans addressed to SMEs even though they may register an increase in global terms (Stiglitz, 2006).

Known it is that in the case of small companies accessing bank financing, liabilities usually are short term with a significant differential in relation to the interest rate that large corporations pay. The cost of the credit for SMEs and the cost for great companies have been in the Nineties of 6 to 8 percentage points, whereas in the European Union it has been of 1 to 3 percentage points (Cristini et al., 2003). On the other hand, as the access to credit of longer term requires greater guarantees than those of short term, given the unavailability of these guarantees, the chance of carrying out investment projects with views to the development of the company, in the case of SMEs was reduced to the mere possibility of re-investing utilities.

These factors, along with the crowding-out as well as the anti-SME slant of adequacy standards demanding greater capital requirements to finance this sector17, determined that -during the Nineties- SMEs could only access 20% of the available credit (Bleger ET al. 2004).

ARGENTINEAN ECONOMY DURING 2001. THE CRISIS

During 2001, several circumstances were generating strong expectations of a currency devaluation. Amongst them: the reversion of international capital flows as a response to changes in risk perception associated to the successive crises undergone by Less developed countries (LDC) economies and to the capital markets’ "flight to quality" in DC, the drop of commodities prices, the deterioration of the competitiveness of tradable goods, macroeconomic imbalances in national economy and the critical political situation.

Expectations concerning currency devaluation were accentuated even more because of the mutual incompatibility of a fixed exchange rate regime with the existence of twin deficits. Fiscal deficit accompanied by the deficit in the balance of payments and the increasing difficulties of both internal and external financing made the convertibility a regime no longer sustainable. As a result of the loss in terms of Convertibility reliability, an increasing deposit withdrawal took place given the loss of market value of bonds in banks’ portfolio18.

Major depositors (in its majority foreign capitals) trying to avoid their exposition to the increasing in the EMBI+, were the first to retire their deposits. This way, a strong capital withdrawal took place.

The intense deposit withdrawal did not stop (it registered a drop of 25.6 % between February and December, 2001) and therefore banks, to preserve liquidity, had to practically suspend the granting of new credits to the private sector. The BCRA, -even with limited functions as a Lender of Last Resort, assisted financial entities suffering difficulties, through rediscounts.

The government, in an attempt to diminish the fiscal deficit ended up exposing itself even more to the risk of default. A policy of “deficit zero” was tried as well as to replace external by internal financing. Also, liquidity requirements that financial firms had to constitute abroad (according to what the prudential regime established), were replaced partially by public securities.

17 Particularly, the establishment of minimum capital requirements based on risk indicators, -meaning based on the level of active rates- desincentivated the credit to SMEs, since as previously specified, the differential of rates with respect to the first class companies, was high. 18 BCRA had to extend the assets margin that could be estimated –accountingly in accrue- to reduce the net worth impact of assets’ loss of value.

9

Finally, a voluntary debt restructuring took place at the beginning of November, 2001. The program consisted of two stages: the first one took care of the local debt holders and second one, of the nonresident debt holders (this one was not carried out). Old National State and provincial bonds and bills were recovered in exchange for loans guaranteed that could be estimated at par value, in exchange for interest rates and in more favorable conditions for the issuer. Debt conversion was offered to financial entities, investment funds, insurance agencies and administrators of retirements and pension’s funds. The interest rate set for the new debt was equal or less than 7%.

If an important group of banks had a peak yield for the majority of their assets, in compensation some measures had to be taken with respect to their liabilities in order to avoid capital loss. But in a context distinguished by a high drop in deposits, a procedure which fixed a peak for the deposits’ interest rate, would stimulate even more the withdrawal. In this situation the freezing of deposits was inevitable.

Deposit drain was particularly intense towards the end of November, 2001. It was this way that, as of the first working day of December, the constraints to cash retirements off bank accounts by account holders was introduced (by means of a Decree), as well as capital flows controls, with the exception of those corresponding to foreign trade operations or the ones linked to credit or debit cards. This measure was popularly known as "corralito". Anyway, it caused a crisis of means of payment. For the sectors in the informal economy who operate exclusively with cash, restrictions to cash retirement caused manifold difficulties.

Banks suspected of insolvency began to undergo a constant drainage of deposits which were transferred to banks enjoying better reputation. It was then necessary to fix high percentages of minimum cash over deposit growth to disincentive banks from expanding at the expense of their competitors.

Currency devaluation expectations generated an alarming gap between the rate of loans expressed in pesos and those expressed in dollars. With the purpose of limiting the growth of active interests, loans expressed in pesos were prohibited. Referring to deposits, it was stipulated that the rates for pesos and dollars offered by the entities had to be equivalent. This caused a greater deposit dolarization. Consequently, many banks became even more exposed in foreign currency, fact that was aggravated by the crisis.

By the end of December, the social and political disturbance triggered the President’s resignation. His successor, who remained in the position for only a few days, declared the default of the public debt.

At the beginning of 2002, the Congress declared the public emergency in social, economic, administrative, financial and exchange matter, through Act 25.561. This way, changes were introduced to the Convertibility Act. The fixed exchange rate regime was abandoned, letting the dollar fluctuate from a fixed relation of USS 1 = $ 1.4. This law entitled the Executive authority to establish the exchange system through which the relation of the peso with other currencies would be set. In addition, it authorized the BCRA to take part in the securities market using its resources or issuing money.

Currency devaluation implied the need for pesification of dollar denominated debt, which with a considerably higher exchange rate, became unfeasible to pay, leaving the financial system in an extremely fragile situation. Then, pesification of constituted liabilities and banking assets expressed in dollars, took place. In order to partially offset the losses of the saving holders, the deposits were pesificated with an increase of 40% in pesos. But this increase meant an enormous load for the indebted ones whose incomes were not dolarized19. Consequently, a system of "asymmetric pesification" was settled: loans (with the exception of those linked to foreign trade financing) were converted into pesos at the rate of USS 1 = $ 1; deposits, at the rate of USS 1 = $ 1.420.

19 The Annual Report to the Congress of 2002, shows that the BCRA considered that near a 70% of the total banking credit expressed in foreign currency, corresponded to debtors whose ability to generate income in dollars was very limited. 20 In the mid 2002, the aspects of compensation tendered by the State –because of the asymmetric pesification- to be received by financial entities, were regulated. The compensation would be orchestrated through public debt (Boden 2007, expressed in pesos and Boden 2012 expressed in dollars, in the case of coverage for negative positions in

10

Also, a regime of fixed term deposit reprogramming was settled down ("corralón"), founding differential guidelines for deposits originally made in pesos and dollars, according to payment schedule, interest rates and amortization systems. Deposits, as it was indicated before, were converted to impositions with adjustment clauses by the retail index of prices (CER). The mortgage credits for housing, as well as retail loans were updated by the Index of Salary Variation (IVS)21.

It is interesting to notice that the banking crisis was not only the cause of a severe credit contraction, but that it also caused a very serious crisis of payment means. Two factors affected the latter: the constraints for cash retirements ("corralito") that stimulated the fact economic transactions be materialized with cash and not through the banking system, with a great loss in terms of efficiency; and on the other hand, the abrupt drop in real terms of the amount of money22.

The role of remonetization, was actually fulfilled by quasi-currencies23 (low-denomination bonds issued by provinces whose role was to substitute the lack of currency -Lecop and diverse "currencies" like Patacones, Lecor, etc.-). The stock grew in 2002 up to $ 4,995 million, which is equivalent to 67% of the increase registered in that year in the circulating currency in the hands of the public. At the cost of the so called "monetary anarchy", these quasi-currencies avoided the depression from deepening even more because of the monetary restriction (Magliano, 2005).

As of the first quarter of 2003, the monetary policy began loosening in correspondence with the significant recovery of the activity level and the necessities of remonetizing the economy. The increase in exports, together with the previous contraction of the imports, alleviated the current account gap and contributed to improve the fiscal position diluting inflationary expectations, which allowed facing -in December of that year- the replacement of $ 7,391 million quasi-currencies, which were exchanged for pesos within the framework of the so called Monetary Unification Program.

On the other hand, the State issued bonds (BODEN) denominated in dollars and pesos which were addressed to the depositors who chose to have a public bond instead of conserving a reprogrammed deposit. The subscription of these was voluntary24. Besides, a great number of bank savings holders obtained the restitution of its deposits via expeditious judicial action of injunction.

The price of the dollar was climbing until it reached its maximum value in June, 2002 (USS 1 = $ 3.87) soon to become stabilized in 2003 and 2004 in values near USS 1 = $ 3.

THE REORGANIZATION OF THE FINANCIAL SYSTEM It was considered that pesification, "corralito" and "corralón" would generate a loss of non-recoverable trust in the financial system, on behalf of the public.

The system was more exposed to the public sector as a result of compensation bonds issued to avoid financial entities’ losses. As the Republic had declared the status of default, the estimate to market values of securities’ holdings and other assets threw negative net worth for some banking firms. For this reason the supervising authority allowed its accounting by technical value.

foreign currency). Pesificated banking assets and liabilities were subjects to indexation by the Reference Stabilization Coefficient (CER).21 Maximum rates were fixed according to lines of loans, in order to avoid the rate in real loan terms -that had been agreed to by a fixed rate- from turning excessive. By mid 2002, guidelines were settled down for financial entities to follow when issuing negotiable titles at self-regulated markets denominated Proof of Reprogrammed Deposits (CEDROS) which would replace deposit reprogramming representative certificates.22 This last phenomenon was a product of the contractive monetary policy recommended by the IMF given the explosion of prices generated by currency devaluation.23 Also known as “bad money”.24 Both bonds expressed in dollars were issued with a 10 year term. The one expressed in pesos, however, had a 5 year term. All bills had price at the capital market.

11

A drastic reduction in the number of banks and financial entities25 was expected; the entities who manage to survive would only function taking care of mere transactional businesses.

In conclusion, it was considered that the savings would not return to the system because of its generalized loss of reliance. Institutional financial system would cease to intermediate funds and would only subsist as a mere transactional bank. As a result, the noncommercial credit would be scarce, plus would be provided by institutions that would operate away from BCRA jurisdiction: credit trust funds, mutual and consumption loans companies, companies of savings and loans with determined aims, off-shore banks, etc.

The steep exit of convertibility together with the situation it entailed made it difficult to think in the recovery of the system. Nevertheless, the system recovered in a relatively short period of time, without external or internal aid.

Contrary to what was expected, only a few banks closed and in those cases they managed to arbitrate so that deposits were out of danger. Losses were suffered because of pesification, but not in terms of internal purchasing power (thanks to CER indexation).

There was no external financial assistance26 of any kind; on the contrary, part of the public resources was destined to cancel obligations with international organisms. With the Republic in default, counting on internal assistance was rarely feasible. Unlike other opportunities, the government did not assist the banks other than by the compensations for asymmetric pesification and negative position in foreign currency. Neither did it decide on solutions that would remedy the short term financial economic situation to leave the economy in an even worse situation in the long term (i.e. the establishment of a mandatory exchange of depositor impositions by bonds).

In fact, policy procedures taken for the purpose of maintaining the financial system (corralito, corralón, pesification) were motivated in emergency reasons exogenous to banks: rigidities of convertibility (the BCRA could not act as a Lender of Last Resort), accumulated exchange rate delay, hyperinflationary background, etc.

Soon after the exchange rate adjustment and the pesification, the financial policy was fundamentally aimed at standardizing the system, progressively eliminating the corralito and the corralón, assisting illiquid banking firms which could carry out their agreements, reorganizing the troubled ones and adjusting accounting standards for the correct estimate of the public sector assets portfolio; that is to say, by market prices but gradually. Finally the recreation of financial intermediation aimed at, adapting prudential standards to facilitate the refinancing of past due liabilities and the rehabilitation of debtors. To this effect, credit regulation was made flexible and long term saving attraction was promoted.

From the beginning, the major banks, including the officials, received BCRA’s assistance due to nonliquidity. The aid found limitations, first as a result of the convertibility regime, and then, suppressed the latter, due to the need to avoid hyperinflationary repercussions. Besides, in 2003, constraints to monetary expansion base were established at Stand-by agreements signed with the IMF were added to these restrictions. The BCRA granted rediscounts (short term loans to illiquid banks) controlling that the bank requiring them faced a deposit decrease consistent with the request.

In addition, the monetary authority considered the capacity of entities to obtain liquidity on their own, i.e.: being assisted by their head office abroad ("shared effort"). As pointed out earlier, during the validity of

25 Banks finally closing as a result of the crisis were seven: Banco General de Negocios, Banco Suquía, Banco Bisel, Banco de Entre Ríos, Scotiabank Quilmes, Banco de la Edificadora de Olavarría and Banco Velox. Also, a small credit savings bank and three other entities without deposits (these did it voluntarily) closed. 26 The IMF recommended a firm policy for the reestablishment of the financial system. It considered that accounting to technical values of entities net worths hid the real situation in which they were, and proposed its estimation to market prices (deteriorated as a result of the default). Entities whose evaluation threw a negative result had to be closed immediately. The BCRA chose to give the system time to recover since the crisis did not have its origin in banking frauds or bad administration of funds.

12

the ‘corralito’, the individuals transferred their funds from the entities where they had originally constituted the deposit to other entities that appeared to have greater adequacy. This phenomenon, called "flight to quality", forced the BCRA to grant rediscounts to the worse affected banks27.

Once the deposit frenzy was surpassed, the problem of rediscount return of was unveiled. The doctrine maintains that the pay-backs must be made at values -over market values- applying a discipline effect. But, in this case, there were concerns that this would attempt against the recovery of the system. On the other hand, if extreme facilities for the return were granted, this would generate moral hazard issues. The adopted solution was known as "matching". It was allowed that falling dues of portfolio securities were matched with those of debt by rediscount, determining for the latter a cost in accordance with the yield of those28.

By the end of 2002 the ‘corralito’ was removed. This event took place before the forecasted date due to economy’s remonetizing, which provided the banks with sufficient liquidity so as to prove the persistence of cash retirement restrictions unnecessary. The process of remonetizing was achieved by the stabilization of the exchange rate thanks to the intervention of the BCRA, who went from carrying out daily sales in the currency market to purchasing them due to the increasing exchange surplus experienced at the end of 2002.

In addition, the drop in international interest rates stopped the capital drain. The economy was too much depressed to raise prices and wages to catch up with the exchange rate. Therefore, the pass-through was low. Once the bullish impulse experienced during the first months was exhausted, prices stabilized and pressures on the exchange market disappeared. Local currency deposits returned quickly to the system since it was not the confidence in the banks that had been deteriorated but the capacity of the system to fulfill the obligations in foreign currency. The uncertainty with respect to the exchange rate derived in short term impositions and renovations only. On the other hand, the registered fiscal surplus during 2003 generated an increase in public sector deposits.

A steady exchange rate was experienced, together with low inflation rates during 2003 and 2004. The entities could place their liquidity surplus in bills or notes emitted by the BCRA without assuming risks.

Regarding the ‘corralón’, the increase in the system’s liquidity allowed -as of January, 2003- for the anticipated return of CEDROS, which implied the end of financial restrictions. The compensation given to banks due to asymmetric pesification in mismatches and rediscounts costed almost 15% of the GDP in addition to the GDP skid of 2002.

The structure of the financial system changed because of the crisis, some foreign banks decided to leave the country, failing to fulfill their expected - by the promoters of foreign takeovers- duties of generating a stronger system acting as the Lender of Last Resort. The Argentinean public realized that public banks, and a portion of national private banks, would not only remain in the country but as well would have a greater financial support and commitment than several foreign banks.

THE AMENDMENT OF PRUDENTIAL STANDARDS

27 The BCRA granted rediscounts due to transitory non-liquidity to 40 firms for $ 15,537 million. This situation forced the BCRA to cover the daily imbalance at the Clearing house. With the purpose of avoiding unfair competition conducts, entities receiving deposit transfers had an imposed reserve ratio that neutralized the growth of their loan capacity. Entities receiving aid had to present a reorganization plan to the Financial Entities Superintendence, who placed inspectors.

28 To this cancellation procedure, entities who reconstructed their debt with other creditors previously (with a diminution of the present value of the debt) were admitted. At the beginning of 2005, the BCRA allowed for the pre-cancellation of rediscounts that already were in this procedure, given the favorable liquidity situation taking place. Entities who pre-cancelled their rediscounts could again apply for assistance by paying a punitive rate.

13

During 2003, several changes took place with regards to "Minimum Capital Requirements for Financial Institutions" standards with the purpose of rebuilding the financial system. The minimum capital requirement set for entities which -as already indicated- was superior to international standards (11.5 % of the risk assets, ratio that increased with the risk indicator requisites) was reduced to 8 % established by Basel standards and risk indicators were eliminated. In order to determine minimum capital requirement in terms of interest rate risk, the risk to which the institution was exposed -according to the behaviour registered the of Reference Stabilization Coefficient (CER) against the rate of fixed term deposits, which establishes the funding cost- was introduced. The market risk requirement attracted the risks implied by exchange rate flotation. Capital requirements were established for exposure at public sector assets, as a compensation for the softening of the net worth requirements. Soon after the debt exchange in 2001 and the compensation received by banks as a result of the asymmetric pesification, half the system’s assets corresponded to the public sector that had declared the default. This is why entities had negative accounting net worth. It was then that an estimate mechanism by which those assets had to register at their present or technical value (the lower of the two). But for the estimation of the present value an application system of increasing discount rates was established which would finally converge to average market rates by January, 2008. In addition, in order to prevent the entities from increasing their public sector exposure, limits were set to their public sector financing29.

Decisive was the limitation of currency mismatches up to 15% of banks’ Adjusted Net worth Liability. Nonetheless, there exist strong pressures from banks so as to increase currency mismatches to allow greater long term credit due to the fact that local currency credit is still minor, which is very risky given the convertibility experience.

RECOVERY OF THE ARGENTINEAN FINANCIAL SYSTEM AFTER THE CRISIS

Within a favorable international context, the Argentinean economy demonstrates a steady growth path at Asian growth rates since 2003, sustained by the solid performances of macroeconomic fundamentals which, along with a competitive exchange rate, allow for the reaching of commercial and fiscal surplus.

Although during the crisis the IFIs point of view was such that Argentinean banks would transform radically reducing their work to that of mere transactional, the financial system showed a superb fast recovery. In this sense, it could –firstly- recover the confidence and retake the winning of both public and private30 sector deposits, thanks to the fiscal surplus.

Likewise, financial firms managed to quickly reduce their liabilities towards BCRA due to the assistance received during the crisis. Not only through the payment by installments corresponding to "matching", but also did they cancel rediscounts early. In the second part of 2005, payments totalized $5,940 million31. Jointly, banks rapidly diminished financial sector exposure, which is explained to a large extent, by the successful culmination of the Argentinean External Debt exchange in 2005.

During 2005, for the first time after the crisis, the financial system obtained a positive yield. The results went up to around 0,9% of the assets, a value that is in alignment with the values registered by other LDC.

This situation, along with the gradual capitalization of banks during that period, contributes to the measured return to system adequacy. (See Chart 2)

29 The percentage of financing to the national, provincial and municipal public sector altogether could not surpass 75 % of Adjusted Net worth Liability (RPC). Public sector assets could not –added up- exceed a top of 40% of total assets, number that lowers to 35% as of 2007. On the other hand, banks were allowed to pay by 60 installments the losses inflicted by dollar deposits returns based on judicial injunctions.

30These experienced a growth $ 7,400 million in the second semester of 2005. 31 Only 3 of the 24 financial firms indebted originally to the BCRA remained indebted by the second half of 2005.

14

Chart 2: Financial System Yields after Crisis 2001-2002

Source: BCRA. Bulletin of Financial Stability. Second semester 2006

Chart 3: Net worth situation of the Financial System after Crisis 2001-2002

20021st half2006

Net worth (% netted assets) Private Sector Loans 22 29,1Public Sector Credit 50 32,4Private Sector Deposits 28 49,9Public Sector Deposits 5 17,9

Source: BCRA. Bulletin of Financial Stability. Second semester 2006

Nevertheless, and in spite of the moderate promotion of private credit, the participation of bank financing in the economy only represented 10% of the GDP by the end of 2005. This means reaching the level of financial intermediation previous to the crisis, with loan coefficients that approached 24% of the GDP, will imply a considerable effort still.

It is worth emphasizing that certain characteristics of the Nineties financial sector remain. On the one hand, together with anti-SMEs slant in credit matter within a highly foreigned and concentrated system, many of the small companies do not qualify as credit subjects. Although the classification of debtors was adjusted, several of them have problems when it comes to updating their fiscal and provisional gaps.

On the other hand, the concentration of credit is a phenomenon persists nowadays. In 2006, seven commodities producing corporations increased their liabilities with banks more than 90%32. These companies represent the engine responsible for credit demand growth. Its contribution to the increase of financing to the non-financial private sector constitutes 10% of the aggregated expansion of 200633.

Concluding, the Argentinean economy has managed to overcome –remarkably fast- the deepest crisis in its history, due to the combination of economic measures that implied a rupture from economic and financial orthodoxy. The local financial system, on the other hand, demonstrated an astonishing recovery if we consider that unlike other countries’ similar crises (i.e. Mexico), Argentina did not get any aid from international organisms.

32 The seven companies are: Cargill, Mills, Siderar, Aluar, Black Hill, Nidera and Dreyfuss. 33 Credits are taken mainly to finance their exports (they destinate 24, 8% of the taken credit for this financing). In addition almost half the debt is taken with a limited number of firms. With the exception of three companies that became indebted themselves to around 20 banks, the rest concentrates 40 % of its financing in 4 banks. It is possible to emphasize that there are two banks, Banco Nación and Banco Francés, the first ones concentrating around one third of the credits to these companies. If credits granted by Bank Boston and Banco Galicia are added, the number comes near 50 % (Report of the consulting Activity, Currency and Finances. El Cronista Comercial, Noviembre 2006).

2001 2002 2003 2004 2005 1st half 2006 Yield (% netted assets average)

Return over Assets (ROA) 0,6 -8,9 -2,9 -0,5 0,9 1,7

Return over Equity (ROE) 4,3 -59,2 -22,7 -4,2 7,1 12,5

15

TOWARDS BASEL II…THE DEREGULATION OF THE FINANCIAL SYSTEM

Financial markets have undergone different transformations since the end of the Eighties. The liberalization of banks in DC granted flexibility to financial institutions when granting credits and making investments. This derived in the creation of a new range of financial instruments such as options and swaps. Although Basel I considered bank’s use of derivatives, the financial entities’ participation in the markets where these instruments are exchanged, the risk associated to such has grown hugely since then.

In addition, financial sector’s deregulation meant that the separation between the banking sector and the securities market ceased. Banks’ investments in different securities gained more importance, leaving them even more exposed to fluctuations in the price of assets.

On the other hand, financial liberalization entailed a gap in terms of institutional barriers between banking and non-banking financial institutions.

Consequently, liberalization produced an increase in competition. Banks from the DC desperately began to seek for new loans and investments takers in economic regions having greater returns, with the consequent risk involved. This financial overexpansion also took place in LDC.

Towards the end of the Nineties, it became evident that banks’ risk profile was undergoing great changes. In addition, an increase in mergers and acquisitions, both intra-industrialists and inter-industrialists took place, causing not only concentration in the financial sector but also intensifying the participation of major financial firms in typically high-risk sectors.

Therefore, globalization along with the rapid change in the structure of financial firms contributed to the appearance of new forms of risk and their consequent fast transmission. This situation generated the discussion of new topics regarding the supervision and regulation beyond the frontiers. Consequently, Basel Committee recognized that Basel I had ceased being suitable in defining capital requirements for this new scenario.

Correspondingly, the explosive growth of the securitization phenomenon of banking credits, in which financial firms often assume total or at least partial responsibilities in case of losses (not entered as possible passive) showed risk underestimation under those standards.

In this sense, Basel II intends to adopt a system of common standards amongst countries suitable to reach greater financial stability internationally given the more and more complex financial development.

On the other hand, the development of credit rating systems by the main banks, convinced the Committee about the convenience of recognizing the rationality capital allocation policies based on those systems, guided to its efficient use.

Nevertheless, the decision making process for these regulations does not come from a multilateral agency with a democratic mandate whose objective is to establish and to reinforce financial norms worldwide. Indeed, IFIs include conditions in their lines of credit implying the adoption of international financial standards like the Core Principles for Effective Banking Supervision of Pillar II (inappropriate for the local financial systems in LDC and incompatible with development processes).

The proposed standards are designed and formulated by the representatives of national monetary supervising authorities of the countries pertaining to the G-10 conformed by the United States of America, Japan and the main European economies, and its adoption by the LDC countries is encouraged through both informal34 and formal35 mechanisms.

34 Amongst these we can find an important issue that is generally taken into account for determining loan concession to LDC, regarding the quality of supervising and regulatory standards measured in terms of adhesion or non-adhesion to such international standards –condition which is also necessary for attracting and holding capital).

16

This way, evidence shows that the New Agreement emerges as an answer to the particular necessities of financial systems in DC with global implementation and scant effective participation in the LDC decisions.

REVISED CAPITAL ACCORD (BASEL II)

As previously stated, the primary target of revising standards of minimum capital requirements is the incorporation of capital exigencies that consider the changes in banks’ structure and their risk administration.

This way, two fundamental innovations were introduced: a greater use of the risk estimation on behalf of the bank itself as an input to estimate regulatory capital36, and the inclusion of the operational risk in addition to the market and credit risks. 37

Its application is consolidated amongst banking groups’ holding companies at their different sublevels.

The Agreement38, originally motivated in 1999, consists of three sections centered in three pillars: minimum capital requirements, supervisory review Process and market discipline. The first pillar describes the alternative approaches available for the calculation of capital requirements according to credit and operational risk. The second pillar proposes the review process that must be carried out by national regulators in order to assure the correct risk estimation of both risks and capital for the banks in their respective countries. The third pillar aims at improving market discipline, requiring banks to make their information public regarding risk exposure and capital position.

Pillar I. Minimum Capital Requirements.

Capital definition and requirements stay the same with respect to the original Agreement. The definition of capital subject to regulation includes some modifications (Tier 1, 2 and 3).

The main difference with Basel I lies in the estimation of risk exposure, which under the new Agreement, will consist on the aggregation of the bank’s credit, market and operative risks. The total risk-weighted assets is determined multiplying capital requirements by market risk and operative risk per 12,5 (the reciprocal one of the minimum capital coefficient of 8%) and then adding the result to the addition of credit risk-weighted assets.

Basel II offers three main options to banks for the evaluation of capital requirements according to their credit and operational risks. The degree of complexity of the approaches is increasing. The options to estimate credit risk are the Standardized Approach and two approaches based on internal ratings (Internal Ratings-Based approaches). But as well, a simplified standardized approach is contemplated in which external ratings of the portfolio are not used. On the other hand, there are three options to calculate operational risk: the basic indicator approach, the standard method and the advanced method. These approaches use different degrees of inputs for imputing operative risk provided by the bank, versus the ones provided by the regulator.

35 Amid these, the key instrument is the ROSC (Report on the Observance of Standards and Codes) which monitors the implementation and accomplishment of the adopted standards, publisher by the IMF as integrating Article IV’s consultancies.36 Basel Committee began incorporating internal risk models starting from 1996 Market Risk Amendment.37 Operational Risk is defined as the risk given by loss resulting from internal processes or inadequate, unsuccessful systems. Loss may result as well from an external event. This definition includes legal risk but excludes strategic and reputation risk. 38 BIS, 2005, International Convergence of Capital Measurement and Capital Standards, A revised Framework.

17

Standardized Approach

This approach is similar to the original approach since it classifies banking assets according to their risk and then it weighs them using fixed weighing factors. However, in this case, risk calibration is based on the qualifications granted by credit assessment institutions or by an export credit agency (approved by the supervisor). There are tables that link ratings with risk weighing factors. These are applied to net exposures with specific provisions. For example, in business credit, qualifications AAA to AA- correspond to a 20% weighing factor, A+ to A- correspond to a 50% weighing factor, from BBB+ to BB- or unassessed credits, weighing factor is 100% and below BB-, 150%.

The National Supervising Authority will be the one in charge to designate each risk weighing factor available under this approach the qualification granted by some of the external credit assessment institutions (ECAI). Nevertheless, banks will have to use the ratings shaped by a single assessment institution for all of their assets.

Unlike Basel I, in which a distinction was made between OECD and non-OECD, risk weighing factors are assigned on the basis of investment-grade and non investment-grade ratings. Nonetheless, risk weight -lesser than bank’s exposure to the Sovereign (or Central Bank)- imputation is allowed when the debt is expressed in local currency. There are other weighing factors for credits in arrears (with delays longer than 90 days), for off balance sheet financing will be turned into credits with equivalent exposure through the use of credit conversion factors (CCF) and for other high risk exposures (investments in private shares, etc.). Likewise, certain loan categories, i.e. mortgage loans, retail loans, leasing, etc. have specific risk weighing factors.

The use of credit risk mitigators (CRM) due to guarantees and netting of creditor and indebted positions from a same counterpart in the banking is admitted. By the simple method, the collateral weighing factor is applied on the covered portion of credit, whereas exposure weighing factor is applied on the uncovered one. By way of the broad method, values fit by collateral security margins at exposure, collateral and currency mismatch are considered. Collateral security margins can be provided by the Supervisor or result from individual estimations.

Simplified Standardized Approach

It does not require external qualifications39 (companies’ weighing factor is 100%, that is: the capital requirement is 8% the same as in Basel I, however for inter-bank loans sovereign risk qualification must be considered – a degree less- of official export credit agencies published by the OECD. Ibídem in the case of non-national Public Sector organizations, unless a National Government treatment is justified).

Concerning securitization risk, banks may invest, but they are not allowed to guarantee or offer repurchase agreements. Its risk-weighing factor is of the 100%. Weighing factors for residential mortgage credits (35%) and commercial (100%), retailers (75%), loans in arrears, high risk financing and financing outside balance, are identical to those of the standard approach.

This simplified approach requires the simultaneous adoption of the Basic Indicator Approach with regards to operational risk.

Internal Ratings Based Approach (IRB)

IRB Approach allows rating assets through measurement and management models designed internally by banks.

39 This is such, because the fact of low penetration of qualifying agencies in various economies –especially emerging ones- is widely recognized, so that most bank portfolios do not have qualification, which is indeed why the standard approach is inapplicable.

18

Banks fulfilling certain conditions and requirements will be able to obtain the supervisor’s approval to use their internal risk component estimations in with the purpose of determining capital requirements. For each class of assets comprised in this approach, three elements are taken into account:

Components of risk: risk parameter estimations made by the banks or the supervising authority.

Risk weighing functions: through these functions the risk components are transformed into risk-weighted assets in order to obtain capital requirements.

Minimum requirements: means the minimum requirements that the bank must fulfill to use IRB approach for a determined class of assets.

Risk weighing functions determine capital requirements according to the portion of unexpected losses (UL) and are built on the basis of the following risk parameters:

Probability of Default (PD)

Exposure At Default (EAD)

Loss Given Default (LGD)

Maturity of Loan (M)

Within this approach two options exist: the basic IRB approach and advanced IRB approach. The main difference between both lies in the amount of risk parameters internally estimated by the banks.

Under the basic approach, entities estimate the probabilities of default (PD) internally but applying the values fixed by the supervisor for the other parameters.

Under the advanced approach entities estimate internally all risk parameters.

In order to obtain risk-weighted assets, capital requirement (K) must be multiplied by EAD and by the reciprocal one of the minimum capital ratio of 8% (factor 12,5). Then, Risk-Weighted Assets = 12,5 x K x EAD.

Capital Requirement by Operational Risk

This one is the risk of losses due to inadequate or erroneous internal processes, employees’ mistakes and systems’ errors, or external events. Also, Basel II offers diverse options on the matter, admitting as well combinations among them:

Basic Indicator Approach

The patrimonial requirement by operative risk will be equal to 15% of the annual average gross income (positive) of the bank during the past three years.

Standardized Approach

Bank activities are categorized in 8 lines of business (corporate finance, sales and commerce, retail bank, commercial bank, payments, agency services, asset administration and retail intermediation). A factor βi

is assigned to each of these lines, it relates the line’s operative risk i to its gross income. The imputed capital is the sum over i of each βi multiplied by the gross income of the line of business i that ranges from 12% to 18%.

19

Advanced Measurement Approach (AMA)

Finally, under the more sophisticated approach (Advanced Measurement Approach), the imputed capital is generated by the bank’s internal system of operative risk measurement. In order to use this advanced approach, banks will have to fulfill certain requirements as: the establishment of a responsible independent unit to measure operative risk (subject to the approval of the supervisor), design and implement internal controls.

Pillar II. Supervisory Review Process

It is the aim of this process not only to get the banks to have enough capital to face the assumed risks but as well to encourage them to develop and use techniques to manage and weigh risk efficiently.

The Committee identified four core principles for this process, which complement those developed previously in the topic of supervision.40

Principle 1: The principle indicates that banks will hold a process in order to evaluate if they have the appropriate capital according to their risk profile. Moreover, they will have to devise a strategy in order to maintain their capital levels.

Principle 2: Establishes that the supervisors will have to examine banks’ strategies and internal evaluations.

Principle 3: Sets that the supervisors must expect banks to operate over the regulatory minimum capital.

Principle 4: This principle settles that they will have to mediate to prevent capital from descending below the established minimum, according to the risk profile of each bank in individual.

Additionally, this Pillar analyzes risks that have been treated only partially in Pillar I, such as credit concentration risk, those that have not received any treatment, such as the liquidity, interest and external effects risks (for example, the effect of economic cycles).

It also includes other aspects such as supervision transparency, accounting, cooperation and communication through frontiers.

Pillar III. Market Discipline

Since the new Agreement grants greater discretion to banking firms when evaluating capital, this Pillar has the main objective of stirring up market discipline by means of spreading truthful and complete financial information (transparency principle). The underlying idea is that, markets with symmetrical information, banks with a lower risk profile will obtain greater support from the depositors. This situation contributes, along with the two remaining pillars, to the stability of the financial system. Doubtless it is that the title and spirit of this pillar is unwise, since recent crises have demonstrated that securities market is not tutoring because market incentives, behaviours and imperfections in general exist (myopia, asymmetry of information, herding behaviour, etc.) which tend to exacerbate financial bubbles and thus, financial crises.

RESTRICTIONS, INSUFFICIENCIES AND MAJOR OBJECTIONS TO BASEL II

40 The Core Principles for Effective Banking Supervision are the keystone principles prudentialwise. They were established by the Financial Stability Forum in 1999, after the Asiatic financial crises.

20

The new international standard regarding capital requirements for financial firms became subject to a wide range of technical objections as well as critics because of the consequences of its application both in DC and in LDC.

Amongst the first type observations there is the lack of an integral risk approach, in spite of its great complexity.

In fact, Basel II displays a confusing or at least insufficient treatment in the matter of provisions; it does not particularly consider liquidity or interest rate risks; nor it contemplates to attenuation of credit risks by means of portfolio diversification; nor does it set down a specific treatment for exchange rate risks.

From the perspective that its application raises some problems, those endogenous to the financial system are indicated in the first place.

On the assumption that the new standard was originally conceived for greater internationally active banks, its broadening to whole universe of financial firms supposes not few problems that turn into competitive distortions, since the size plays a crucial role here, in the absorption of high implementation costs required for the advanced approaches (systems development, hardware update, hiring and skilling of proficient staff, etc.).

It is indeed credit institutions with greater spread who can end up being beneficiaries of the implementation of these approaches, which are able to generate a reduction in capital integration requirements.

In addition, LDC do not posses developed credit informative systems, or at least have relative trustworthiness, which is why it will require a certain amount of time to develop consistent databases that allow for the estimation of parameters to be applied in the new adequacy standard.

Correspondingly, it turns banking supervision more complex and more expensive. In addition, it is hindered by the given shortage of highly skilled human resources, especially in LDC. For example, in Latin America, a few years ago it was considered that 60% of controlling agents required that they be especially skilled.

Regarding the problematic macroeconomic perspective, it has been extensively pointed out that the three Basel II pillars would accentuate the economies’ pro-cyclicality, whereas greater risk sensitivity may restrict credit supply to SMEs.

From an international standpoint, the introduction of this adequacy standard, would also affect the financing of LDC (capital-receptor economies), affecting capital flows and costs of financing. Additional difficulties of enforcement appear in these economies, especially given the little diffusion in terms of external rating systems and the lack of reliable statistical records, necessary for the construction of risk models. Also, comprehensible difficulties may arise in the construction of an efficient supervising regime in accordance to Basel II, but as markets and IFIs will use as a reference for weighing banking systems adequacy, the fact that these have actually adopted or at least plan to adopt the new Agreement, those that do not do it will undergo economic punishments (by means of greater interest rate or credit rationing). It is for that reason that in the last BIS survey (September 2006) conducted to 98 countries not members of the Basel Committee, 82 responded that they will try to introduce the international standard, although slightly diferring about the admitted approaches.

Finally, it must be recognized that Basel Regulation Committee responded the different critics formulated and introduced more flexibility in the scheme by allowing the adoption of different approaches, even, the combination of such (i.e. IRB approach for internationally active banks and the simplified standard approach for the rest of the financial system). Nonetheless, several of the exposed difficulties subsist.

Next, a more detailed analysis is made concerning the main problems related to Basel II, as well as specific commentaries relative to the different approaches.

21

PRO-CYCLICALITY AND SHORT-TERM BIAS ISSUES

The financial sector, as well as the real one, happens to be strongly correlated. A good performance in the first stimulates economic growth by means of canalizing savings towards investment. Also, the financial system is sensible to real economy evolution, since it is not only sustained by the underlying economic reality, but it also reflects it.

This interrelation is observed along the joint movement of several financial fundamentals and the economic evolution, in which positive correlations between them arise, generating consequently a certain degree of pro-cyclicality. This way, during the ascending phase of the economic cycle, optimism usually increases, affecting risk perception, conduct that attaches an undesired increase in risk exposure by means of the over-indebtedness. On the other hand, when the economic cycle is reverted and some incurred risks are materialized, it produces a trim in exposure and worsens pessimism, restraining credit availability.

As previously mentioned, it is the aim of Basel II financial stability reinforcement by means of incorporating a more sensible risk measurement, together with a wider regulation on behalf of the supervising authority.

The application of this standard supposes that minimum capital requirements become more sensible to risk measurement. Risk measurement is pro-cyclical whether it is brought about through the standard approach or by the IRB approach (in all of its modalities). This pro-cyclicality in credit ratings would create a similar pro-cyclicality in capital requirements, with the implied consequence of banks maintaining less capital during cycle peaks, whereas during the recessive phase, they would have a superior level of capital than that required by macroeconomic stabilization calling for credit expansion. Therefore, a first glance to Basel II would result in greater pro-cyclicality in terms of minimum regulatory capital.

Nevertheless, the final Agreement introduced a series of measures aimed at attenuating the greater pro-cyclicality, amongst which we can mention the smoothing of the capital requirement curve (which reduces volatility of minimum capitals based on non-payment probability) and the compulsiveness by which model made estimations should estimate the probability of default as a long term median during one complete economic cycle. This measurement would be reinforced by the introduction of an improvement of risk measurement brought about by relevant parameter estimations along the cycle and greater provisions along peaks41.

On the other hand, it is important to emphasize, that the new Agreement introduces a modification in the definition of short term that could exacerbate pro-cyclicality. In Basel I, this definition is referred to a one-year term. In Basel II, the term is reduced to 3 months. This measurement can typically generate greater volatility in financial flows towards LDC which offer comparatively higher yields than DC, since short-term loans count on smaller capital loads than those of greater term (González Speck, 2004). Therefore, it could be -indirectly- stimulating an increase in short-term operations (greater volatility) in speculative movements of capitals with a consequent greater fragility that it would produce in the affected financial systems. This would affect and even go against the Committee’s objective itself to improve global stability by increasing the risks and rendering them more vulnerable to these markets (FELABAN, 2003) against a possible crisis that could induce to a financial contagion to the rest of the economies. An increase in short term operations clearly does not imply a boost towards financing, for the reasons that will be indicated ahead.

RISK AND DIVERSIFICATION: Higher Costs to LDC

41 In order to attenuate minimum capital regime caused pro-cyclicality in Spain, a system of anti-cyclical provisioning was designed. During the cycle’s expansive phase, entities must contribute with resources up to a certain point (equivalent to the threefold sum of various credit risk categories, adjusted by their correspondent coefficients) (Magliano, 2001).

22

The generalized application of IRB approach on behalf of internationally active banks would imply an increase in capital requirements when they finance low-rated credit takers, as it is the case of most LDC countries. Depending on the degree of correlation between minimum capital requirements and credit cost and its availability, the total financing costs would increase substantially in price, then generating rationing of credit by price, typically to finance countries, restricting even more the flow of capitals towards them.

On the matter, it is appropriate to emphasize that amongst the advantages involved in investing in LDC, there is the low correlation between these markets and the DC’ markets. This way, the banks who make their asset portfolio distributing between barely correlated markets, would obtain gains by diversification, secure a safer portfolio, instead of concentrating the risk by means of investing in highly correlated markets (Griffith-Jones et al., 2004).

Nevertheless, Basel II does not include any mention on the benefits derived from diversification42, which could moderate the negative effects derived from capital movements towards LDC because of the application of the IRB approach by means of a reduction in the requirements of minimum capital.

In fact, low credit ratings and high sensitivity to probability of default (PD), as well as losses given default (LGD) will reduce the capital flows as much in amount as in price as a consequence of the increase in credit cost given a greater risk premium.

STANDARD APPROACH AND INTERNAL RATINGS BASED MODELS (IRB)

As it was indicated before, Basel II introduces two methods for the estimation of the minimum capital for risk assets, one is the standard approach and the other one is the IRB (basic and advanced). Although the standard approach is more similar to the one established in Basel I and introduces greater risk sensitivity to in weighing factors, the evaluation of risk would be calculated by rating agencies and through these qualifications, risk weighing factors would be in a range from 0% to 150%.

The disadvantage displayed by the standard method is that the minimum capital will be greater than with IRB43 method, since it operates as an incentive for banks to choose the second approach in order to obtain a more efficient risk management.

Additionally, IRB approach hints a high implementation cost, given its complexity, which would make it necessary to train employees, technology updating, etc., reasons why most of local capital banks operating in LDC would adopt the standard approach. This would cause a strong competitive imbalance between local and foreign banks, since the latter count on greater scale and resources would possibly operate under IRB approach, which would grant them an advantage in being able to choose a better credit portfolio through more risk sensible models, leaving the rest of the banks the portfolio with worse credit quality (Garcia Blacksmith et al., 2006). Also, another disadvantage on scene is the one of supervision difficulty, since the supervising authority, in charge of validating and controlling the models, would need to count on highly skilled staff in order to understand and evaluate banks’ credit risk systems.

Therefore, major internationally active banks compel LDC to adopt IRB in order to reduce capital and to have comparative advantages derived from the use of expensive internal models.

On the other hand, the standard approach also presents disadvantages for LDC. These issues are: the lack of rating agencies, their insufficient degree of penetration in markets, which derives in shortage of qualified credit candidates and in the high degree of informality related to these economies not allowing their work (Partal Ureña et al., 2004).

42 The ratings system considers the individual risk of each asset, this way correlation of different risks along time cannot be contemplated, which is bad since it allows weighing global risk and, in some cases, attenuating requirements because of lesser risks derived from diversification.43 Results of the fifth quantitative impact study (QIS 5) (2006).

23

Hence, the introduction of the international standard would impair the assistance to economic agents who, because of their smaller dimension, have comprehensible difficulties to absorb the mentioned costs of being rated44. Being the rating a compulsive element and not counting with an appropriate development, this deficiency will be transformed into greater costs of intermediation for the financial system, increasing in price the credit.

A hitch related to rating agencies45 is the increasing competition between them. This situation could bring about moral hazard since they would have incentives to use favorable ratings in order to gain market share within the structure of a clearly oligopolic market. Also, this conduct coupled with smaller minimum capital requirements for the banks, could turn the financial system even riskier.

The simplified standard approach has the advantage that it does without external ratings, thus resembling Basel I as far as the uniformity in capital requirement. However, it demands the simultaneous adoption of the capital requirement in terms of operational risk, according to the basic indicator approach (consisting in covering risk with a minimum capital equivalent to a fixed percentage of 15% of the last three years’ gross income). Although this modality would be the most embraced in terms of adoption of international standard of adequacy by DC, for the reasons previously mentioned, it would imply an additional exigency of capitalization in their respective financial systems.

BASEL II AND SMEs

Some authors analyze certain aspects referred to the costs of financing the SME sector46. This preoccupation originates in the concern that under Basel II, banks will allocate credit destined to what is described as high-risk enterprises by means of a raise in interest rates. The proposed solutions are smaller charges to financing SMEs and an increase in the variety of collaterals that can be used.

Basel II might have a negative impact on the availability and cost of SME financing. Capital requirements in terms of credit risk regarding SMEs will tend to increase under the new Agreement; also financing costs should not be raised as a consequence of intensive exercise of internal ratings used as a foundation to establish loan prices. Those who share a more optimistic view admit that the Agreement could imply greater capital requirements for certain sectors of the small industry. As it was previously mentioned, this would be caused by the different qualities in terms of credit displayed by credit takers (Price Waterhouse Coopers, 2004).

THE IMPLEMENTATION OF BASEL IIBASEL II IN ARGENTINA

In December, 2006 the BCRA, made public its decision to adopt the simplified standardized approach for credit risk regarding Pillar I, along with the convergence schedule towards Basel II, whose implementation will be as of January 2010. The considerable delay in the announcement is explained by the effect of the severe crisis of 2001-2002 that required time for the recovery of the financial system.

In 2009, the parallel estimation of capital requirement in terms of credit risk will be made, applying the risk weighing factors in force in the BCRA regulation, as well as those corresponding to the simplified standardized approach.

44 Even though, it is true that for SME portfolio, as well as personal loans financing, credit cards, pledge credits and leasing, generic weighing factors are applied.45 Besides, the ratings bestowed to equal credit-eligible entities by different rating agencies, during the last crises have been gaudily divergent (Jón Daníelson et al., 2001). 46 The following paragraph condenses the core of this matter: The debate often assumed that interest rates for loans to SMEs were likely to rise, as these customers are generally of lower average credit quality than large corporations and, thus, would require higher regulatory capital than under the existing rules (Price Waterhouse Coopers, 2004).

24

Apropos of the computation of minimum capital requirements, the simplified standardized approach, as it were mentioned previously, is Basel I’s most resembling method, let aside improvements on the subject on risk measurement by means of adjustments in weighing factors (specially in the treatment of the sovereign risk), the introduction of credit risk mitigators (CRM) and updates as to the first Agreement in the topic of financial derivatives, as it is it the incorporation of securitization.

The BCRA has not pronounced itself yet in as much as the new capital requirement, subject to the operational risk. However, within the three options available to estimate this risk, it seems only the simplest approaches (basic indicator or standardized approach47) have chances of being chosen. It is worth emphasizing, that the requirement, in terms of risk-weighted assets, was appraised to oscillate around 2% in average, for Argentina in 2004, with a great dispersion among the different banks.

At first sight, this could imply an additional net worth requirement that would mainly affect the smaller firms when struggling to capitalize themselves in order to fulfill the minimum capital requirements in operational risk terms. Anyhow, the BCRA not having defined on the approach or on its execution schedule, cannot yet itemize the impact on the financial system.

It is interesting to remember that by the mid Nineties, together with the implementation of Basel Plus, an increase in the minimum capital requirements was settled which severely affected smaller scale banks who were not being able to satisfy these requirements, and were taken up by greater spread banks (national but mostly foreign), conforming a highly concentrated banking system and foreignly taken over, generating negative effects on credit towards SMEs and on the retail sector.

On the topic of the Supervising Process articulated in Pillar II, the BCRA will have more power for monitoring that sector, but it will indeed demand greater resources. By 2007, the first stage of revision of prudential regulation and processes of supervision based on good risk administration practices contained in the "Basic Principles for an Effective Banking Supervision", as well as in the best practices released by the Basel Committee48, will begin, presumably ending the last phase in 2009, year in which this Pillar will be performed.

The Third Pillar will provide the principles to achieve greater transparency in the market rectifying the flaws of asymmetric information so as to prevent the agents from incurring in adverse selections. This way, they will be able to get to the necessary information to make saving and investment decisions. Therefore, the BCRA will monitor banking institutions to make sure they publicize the activities they engage in, their diverse risk exposures, etc. According to the Road map published by the monetary authority to be applied by 2009, a target of analysis will be the gap between the required information and the information actually provided.

BCRA’s decision seems right in that it posits to converge to Basel II through the simplest method suitable for LDC financial systems, preventing the generation of competitive that would have been an issue, had they decided on the IRB approach, comprising greater margins to generate both prudential and political credit standards established by the Government, the regulator and by the private sector, not avoiding the use of external qualifications. However, it remains on hold the election of the approach to be used in terms of operational risk, by the monetary authority.

A LONG AND WINDING ROAD

By the end of 1994, the Tequila crises in Mexico showed the deficiencies implied in Basel I’s standard of adequacy, as a consequence of insufficiency and slackness of the accounting standards, which aided at hedging the non-collectable portfolio. Later on, the Argentinean financial crises ensued in 2001-2002, confirmed the inefficiency of the reinforced version of Basel I (Basel Plus) to prevent it. The reason is that the international standard of adequacy was designed in accordance with the G-10 countries’ financial

47 It is important that banks posses adequate operational risk systems, observant of the animal outlines provided by the Third Consultive Document published by the BIS, as a condition to pick the standardized approach.48 Road Map for the application of Basel II (BCRA, 2007).

25

systems, which explains why at least two of the risks that actually lead to that crisis, were not even considered. On the one hand: the risk associated to the exposure of the public sector and, on the other hand, the exchange rate risk, being the latter a key factor in LDC, where exchange rate volatility is frequent. As a matter of fact, the concentration and foreign take over of the financial system not only not added proper prudence but aggravated the allocation of credit affecting the economy as it became plainly demonstrated in the Argentinean case.

During the crises, Basel Plus’ rules, along with recommendations of the IMF thwarted credit recovery necessary for economic reactivation, which was why BCRA’s decision turned out to be accurate in following a forbearance policy that granted time to recover banking adequacy, striking at the specific issues of the Argentinean financial system. The monetary authority as well limited, by means of regulations, the risks associated to the rate of exchange and exposure of the financial sector to the public sector, allowing for fast recovery and normalization of the system.

Basel II appeared on the scene as an updated version of Basel I, product of the global advent of new financial instruments with its associated risks. Nevertheless, the New Accord still responds to the specific needs of the G-10 countries’ financial systems, whose representatives do in fact compose the Basel Committee. Moreover, qualms generated by pro-cyclicality and short-term bias have not yet been sorted out, on whether Basel II may in fact be an important step forward towards the adoption of such thing as an architecture for the global financial system, capable of preventing financial crisis.

This way, LDC remain without formal and effective participation in the formulation of the new exigency of minimum capital and of the standards of transparency and supervision. Even if not formally acknowledged, these economies are under diverse kinds of pressure to converge to Basel II not to be isolated of IFIs as well as multilateral development banks. This convergence takes place individually, without having countries decide on a common strategy on the matter, fact which atomizes their negotiating power. Within MERCOSUR, Argentina and Brazil have not yet agreed on a common strategy.

In LDC, coordinated effort is required so as to turn the BIS into a more democratic multilateral agency able to tender a strong regulation for the banking system, together with other agency regulators to account for the complementary and indispensable needs of global financial stability -threatened by globalization and financial liberalization- and of economic development.

Although the new regulation will bring about some improvements regarding credit risk measurement and transparency in global banking system, it must be noticed that Basel II is an extremely complex49 standard of capital adequacy set for globally active banks of great operating scale, which will benefit these allowing them to spare capital. Thus, it will introduce competitive distortions in the market and will still accentuate the asymmetries between national financial sectors. Furthermore, in order for the strong role of the supervisor established in the Accord to be exerted, it will be needed to count up on the necessary resources (human as much as economic) to validate the models and to control financial firms; all of which are possibilities that may satisfactorily occur only in the developed nations.

The simplified standardized approach is the most similar to Basel I amongst the options tendered by Basel II. The improvements will arise from the implementation of Pillars II and III, which will grant greater presence to the supervisor and more transparency to the financial system when having to make public the information concerning their exposures, costs, products, etc.

In the Argentinean state of affairs, by the end of 2006, the BCRA announced the adoption of the simplified standardized approach as of 2010, without still pronouncing itself on the approach to choose in regards to operational risk. It is expected that it will not particularly stun smaller sized entities when having to cope with capitalization in order to come to terms with the New Accord.

49 Fact which is admitted not only by the heterodox and critic speakers coming from LDC, but also by U.S. Republican congressmen , and even the U.S. and G-10 bank representatives themselves. Examples of the above are some BBA documents, and LIBA in England.

26

Given the present situation and the constraints of the New Basel Accord, the Argentinean choice turns out to be a positive step towards minimizing converging costs. Along that period, -once the emergency state has been overcome and baring in mind the lack of high-skilled resources previously described- a regulatory framework that combines both proper prudence and mechanisms that serve the promotion of credit towards real economy, SMEs and consumers in reasonable financial conditions, must be created. So, regulation must contemplate and encourage a diversified banking system with strong national presence public and private, cooperative, and credit accounts able to meet the demands of both savers and credit takers, within a framework of an economic and social development process.

REFERENCES

ABA (1999): "La evolución del sistema financiero en la década del ´90", Ciclo de conferencias. Ascúa, Rubén (2005): "Financiamiento para pequeñas y medianas empresas (PYME). El caso de

Alemania. Enseñanzas para Argentina.", Serie estudios y perspectivas, CEPAL. Bank for International Settlements (BIS) (2005): "Regional Seminar on the Supervisory Review

Process (Pillar 2) of Basel II" Noviembre 2005, Buenos Aires, Argentina. Basel Committee on Banking Supervision (BCBS) (2001): "Overview of The New Basel Capital

Accord", Consultative Document. Basel Committee on Banking Supervision (BCBS) (2004): "Consensus Achieved On Basel II

Proposals", Press Release. Basel Committee on Banking Supervision (BCBS) (2005): "An Explanatory Note on the Basel II

IRB Risk Weight Functions", documento de consulta. Basel Committee on Banking Supervision (BCBS) (2006): "Results of the fifth quantitative impact

study (QIS 5)", documento de consulta. BCRA (2006): "Boletín de Estabilidad Financiera, primer semestre 2006" Banco Central República

Argentina. BCRA (2006): "Boletín de Estabilidad Financiera, segundo semestre 2006" Banco Central

República Argentina. Bleger, Leonardo (2000): "El proceso de concentración y extranjerización del sistema bancario

argentino durante los 90", Boletín Informativo Techint 301-2000. Bleger, Leonardo y Borzel, Mariano (2004): "La crónica restricción de acceso al crédito de las

PyMEs argentinas. Diagnóstico y Propuestas", Las Pymes Argentinas, mitos y realidades, ABAPPRA.

Bleger, Leonardo Y Rozenwurcel, Guillermo (2000): "Financiamiento a las PYMES y cambio estructural en la Argentina. Un estudio sobre fallas de mercado y problemas de información", Desarrollo Económico, Vol.40 nº 157.

Caruana, Jaime (2004): " Keynote Remarks for a Panel Discussion on Basel II - Emerging Market Perspectives", Bankers´ Conference in New Delhi.

Comité de Basilea para la Supervisión Bancaria (2001): "El Nuevo Acuerdo de Capital de Basilea", documento de consulta.

Cristini, Marcela ; Acosta, Pablo y Susmel, Nuria (2003): “Productividad y crecimiento de las PYMES: la evidencia Argentina en los 90”, Documento de Trabajo Nº 76, FIEL.

Daníelsson, Jón; Embrechts, Paul et al. (2001): "An Academic Response to Basel II", Special Paper Nº 130, LSE Financial Markets Group.

Del Pino Suárez, Marina (2003): "Reforma del Estado en el BCRA. La regulación y supervisión del sistema financiero en los años 90. ", Tesis de Maestría, UDESA.

FELABAN (2004): "Efectos de la implementación del Acuerdo Basilea II en los mercados emergentes", Conferencia sobre Efectos de la implementación del Acuerdo Basilea II en los mercados emergentes.

Frediani, Ramón (2002): "El sistema bancario argentino 1990-2001: Propuestas para su recuperación", Actualidad Económica, Año XII, Nº 53.

García Herrero, Alicia y Gavilá, Sergio (2006) :"Posible Impacto de Basilea II en los países emergentes", Documentos Ocasionales Nº 0606, Banco de España.

González Mota,Emiliano (2006): "Prociclicidad, volatilidad financiera y Basilea II", Estabilidad Financiera Nº 8, Banco de España.

27

Gould, David (1995): "México´s crisis: Looking back to assess the future", Federal Reserve of Dallas, Economic Review, 2nd Quarter 1995.

Griffith-Jones, Stephany; Segoviano, Miguel y Spratt, Stephen (2002): "Basel II and Developing Countries: Diversification and Portfolio Effects, IDS y LSE.

Griffith-Jones, Stephany; Segoviano, Miguel y Spratt, Stephen (2004): "CAD3 and Developing Countries: the Potential Impact of Diversification Effects on International Lending Patterns and Pro-cyclicality".

Gruben, William y McComb Robert (1997): "Liberalization, Privatization And Crash: Mexico´s Banking System in the 1990s", Federal Reserve of Dallas, Economic Review 1st quarter.

Gunther, Jeffery; Hooks, Linda y Robinson, Kenneth (1997): "Are Capital Requirements Effective? A Cautionary Tale From Pre-Depression Texas), Federal Reserve of Dallas, Economic Review, 2nd Quarter 1997.

Heid, Frank (2003): "Is Regulatory Capital Pro-cyclical?" A macroeconomic Assessment of Basel II", Deutsche Bundesbank.

Kessler, Ana y Rubini, Héctor (2004): "Financiamiento a las PYMES en Argentina: Una revisión reciente."

Kupiec, Paul (2001): "The New Basel Capital Accord: The Devil Is in the (Calibration) Details", IMF working paper.

Latin American Shadow Financial Regulatory Committee (2001): "The New Basel Capital Accord and Financial Stability in Latin America", Statement Nº 2.

Magliano, Augusto (2001): "El carácter cíclico de la actividad crediticia", Ed. ADEFI (Asunción del Paraguay).

Magliano, Augusto, Elespe, Douglas, et al. (2005): "La recuperación del sistema financiero argentino", Ed. Sol Comunicaciones, Buenos Aires.

Milne, Alistair (2001): "Minimum Capital Requirements and the Design of the New Basel Accord: A Constructive Critique", Journal of Financial Regulation and Compliance.

Partal Ureña, Antonio y Gómez Fernández Aguado, Pilar (2004) : "Influencia de Basilea II en la financiación bancaria de los países emergentes", Boletín Económico de ICE Nº 2826.

Pou, Pedro (2003): "El sistema financiero y la reconstrucción del ahorro en la Argentina", Conferencia 40 años de FIEL.

Powell, Andrew (2002): "A Capital Accord for Emerging Economies?", Universidad Torcuato Di Tella and Visiting Research Fellow, World Bank.

Powell, Andrew (2004): "Medición de riesgo crediticio, requerimientos de capital y previsiones: aplicación de un modelo de portafolio a la central de deudores", BCRA.

Rodriguez, Carlos (1998): "Comparación de las crisis asiática y mexicana", Actividad Macroeconómica (Edición especial).

Rojas-Suarez, Liliana (2001): "Can International Capital Standards Strengthen Banks in Emerging Markets?" Institute for International Economics Working Paper Series.

Schmidt, Susan (2006): "A US perspective on Basel II Implementation", Seminar on the Impact of Basel II on Financial Markets and Business Strategies, Institute for International Bankers.

Secretariat of the Basel Committee on Banking Supervision (2001): "The New Basel Capital Accord: an explanatory note", documento de consulta.

Smitha, Francis (2006): "The revised Basel Capital Accord or Basel I: The Logic, Content and Potential Impact for Developing Countries", IDEAs.

Stiglitz, Joseph (200g5): Cómo hacer que funcione la globalización?, Ed. Taurus, Barcelona. Vicens, Mario (1997): "El crédito en la Argentina: Factores de sobrecosto", Convención nacional de

bancos, ADEBA. Wierzba, Guillermo y Golla, Jorge (2005): "La regulación bancaria en Argentina durante la década

del noventa", Documento de Trabajo Nº 3, CEFID - AR.

28