1

11

Some Lessons From the Recent Financial Crisis in Argentina (2001/2)

Mario I. BlejerMario I. BlejerDirector, Centre for Central Banking StudiesDirector, Centre for Central Banking Studies

Bank of EnglandBank of EnglandSeminar on Crisis Prevention in Emerging MarketsSeminar on Crisis Prevention in Emerging Markets

Singapore, July 11, 2006Singapore, July 11, 2006mario.blejer@bankofengland.co.uk © Bank of England

The Bank of England does not accept any liability for misleading or inaccurate information or omissions in the information provided.

22

1.1. Financial Fragility and the Role Financial Fragility and the Role of Standardsof Standards

2.2. The Consequences of Excessive The Consequences of Excessive Government InterventionGovernment Intervention

3.3. The Importance of Proper The Importance of Proper Liquidity ManagementLiquidity Management

2

33

4.4. The Role of Foreign BanksThe Role of Foreign Banks

5.5. The The ““CurrencyCurrency”” ProblemProblem

6.6. Capital ControlsCapital Controls

7.7. Other Issues Other Issues

44

Real GDP Real GDP (base 1993)(base 1993)

-20%

-15%

-10%

-5%

0%

5%

10%

15%

I-98

III-98

I-99

III-99

I-00

III-00

I-01

III-01

I-02

III-02

I-03

III-03

I-04

III-04

I-05

230

240

250

260

270

280

290

300

var. a/aPBI real

3

55

Poverty and Extreme PovertyIn percentage of the Population

0

10

20

30

40

50

60

Poverty

Extreme Poverty

66

1.1. The Nature of the Argentina CrisisThe Nature of the Argentina Crisis

The Argentine crisis was The Argentine crisis was bothboth a a CURRENCYCURRENCYand a and a BANKBANK crisis crisis –– InterInter--related but related but caused by a number and combination of caused by a number and combination of different factorsdifferent factors

Analytically, better to distinguish between Analytically, better to distinguish between them in an explicit mannerthem in an explicit manner

4

77

THE CURRENCY CRISISTHE CURRENCY CRISIS

The Currency Crisis reached its peak with The Currency Crisis reached its peak with the January 2002 devaluation. It is usually the January 2002 devaluation. It is usually analyzed in the context of the analyzed in the context of the ARGENTINE CURRENCY BOARD ARGENTINE CURRENCY BOARD SYSTEMSYSTEM,, established in 1991 as an antiestablished in 1991 as an anti--inflationary devise. inflationary devise.

The question to be analyzed is: The question to be analyzed is: What were the main causes for the What were the main causes for the demise of the convertibility regime?demise of the convertibility regime?

88

THREE APPROACHES:THREE APPROACHES:

1. The loss of competitiveness of the 1. The loss of competitiveness of the Argentine economyArgentine economy

2. Macroeconomic policy inconsistencies 2. Macroeconomic policy inconsistencies

3. The 3. The ““Sudden StopSudden Stop”” argumentargument

5

99

Tradables/non tradables (WPI/CPI)

Convertibility average101

224220

148

70

90

110

130

150

170

190

210

230

250

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

Ene-

02

Mar

-02

May

-02

Jul-0

2

Sep-

02

Nov

-02

Ene-

03

inde

x 20

01=1

00

1010

-4,0%

-3,0%

-2,0%

-1,0%

As percentage of GDP

0,0%

1,0%

2,0%

3,0%

1993 1994 1995 1996 1997 1998 1999 2000 2001

0%

10%

20%

30%

40%

50%

60%

Overall Result Primary Surplus

Total Debt (2° axis) EMBI Spread (2° axis)

Fiscal Fiscal misalignementmisalignement turnedturned thethe burdenburden ofof thethe debtdebtunsusutainableunsusutainable

Public Debt

6

1111

-4,0%

-3,0%

-2,0%

-1,0%

As percentage of GDP

0,0%

1,0%

2,0%

3,0%

1993 1994 1995 1996 1997 1998 1999 2000 2001

0%

10%

20%

30%

40%

50%

60%

Overall Result Primary Surplus

Total Debt (2° axis) EMBI Spread (2° axis)

Fiscal Fiscal misalignementmisalignement turnedturned thethe burdenburden ofof thethe debtdebtunsusutainableunsusutainable

CountryRisk

1212

Interest Payments/GDP

0

5

10

15

20

1993 1994 1995 1996 1997 1998 1999 2000 2001

7

1313

-10%

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

IV 9

4

IV 9

5

IV 9

6

IV 9

7

IV 9

8

IV. 9

9

IV. 0

0

IV 0

1

-35.000

-30.000

-25.000

-20.000

-15.000

-10.000

-5.000

0

5.000

10.000

15.000

Capital Flow s and Economic Activity Capital Flow s and Economic Activity (Accumulated 4 quarters (Accumulated 4 quarters -- U$Sm. GDP Cyclical Component)U$Sm. GDP Cyclical Component)

Capital FlowsPrivate Sector

GDP GrowthRussian Crisis

1414

-2%

-1%

0%

1%

2%

3%

4%

1998

-I

1998

-II

1998

-III

1998

-IV

1999

-I

1999

-II

1999

-III

1999

-V

2000

-I

2000

-II

2000

-III

2000

-IV

2001

-I

2001

-II

Arg

entin

a

-1%

0%

1%

2%

3%

4%

5%

6%

7%

8%

Chile

Argentina

Chile

Sudden Stops in Argentina and Chile(Private Capital Flows, Percentage of GDP

8

1515

Financial Vulnerabilities to Capital Flows Reversals

Brasil ChileArgentina

Private Sector ExternalUnhedged Exposure

= HighVulnerability

Public Sector ExternalUnhedged Exposure

Public Debt (% of GDP)

Banking Sector ExposureTo the Public Sector

= MediumVulnerability

=LowVulnerability

1616

THE BANKING CRISISTHE BANKING CRISIS

While the problems of convertibility and the While the problems of convertibility and the

consequent exchange rate uncertainty consequent exchange rate uncertainty

played a role, the played a role, the bankingbanking crisis was crisis was

largely caused by the largely caused by the government government

““abuseabuse”” of the banking sectorof the banking sector, given , given

its inability to to adjust the budget deficitits inability to to adjust the budget deficit

9

1717

1.1. The Fragility of Financial InstitutionsThe Fragility of Financial Institutions

The Argentine experience indicates that solid solid

and solvent financial structuresand solvent financial structures—that

comply well with international standards—

could deteriorate quickly in the face of could deteriorate quickly in the face of

inadequate interventionsinadequate interventions, distorted

incentives and misguided policies.

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The Argentine Bank RunThe Argentine Bank Run

BetweenBetween MarchMarch 2001 and 2001 and JulyJuly 2002, 2002, DepositsDeposits fellfell fromfrom U$SU$S 85b. 85b. toto U$SU$S 15b. 15b.

DomesticDomestic CreditCredit toto thethe privateprivate sector sector fellfellfromfrom U$SU$S 54b. 54b. toto U$SU$S 14b. and 14b. and continuedcontinuedtoto fallfall untiluntil thethe endend ofof 2003.2003.

10

1919

The Argentine Bank Run: The Evolution The Argentine Bank Run: The Evolution of Private Deposits (2001of Private Deposits (2001--02)02)

50

55

60

65

70

75

80

30-Sep 21-Dec 13-Mar 3-Jun 24-Ago 14-Nov 4-Feb 27-Apr 18-Jul

“Corralito”

Devaluationand

Pesification

2020

Credit to Private SectorCredit to Private Sector

Loans to Private Sector Evolution

20

25

30

35

40

45

50

1-Feb-02 15-Mar-02 8-May-02 20-Jun-02 2-Aug-02 16-Sep-02 29-Oct-0211-Dec-02 24-Jan-03 7-Mar-03

Billion ARG $

Nominal Stock Real Stock

11

2121

The fact is that weak financial sectors are The fact is that weak financial sectors are not necessarily crisis prone. Financial not necessarily crisis prone. Financial crises have been generated, in many crises have been generated, in many instances, by inconsistent policies and by instances, by inconsistent policies and by an unstable macroeconomic an unstable macroeconomic environment.environment.

In this context one need to rethink the In this context one need to rethink the emphasis put on the emphasis put on the ““enforcementenforcement”” of of conventional standards and codes (and conventional standards and codes (and the cost/benefit ratio of the exercise) the cost/benefit ratio of the exercise)

2222

Comments on StandardsComments on StandardsCurrent policy paradigm is dominated by the effort to converge to international standards. It is misguided to equalize financial stability and financial and financial development development with convergence to standards.

Standards based on industrial countries institutional settings may have unexpected negative impact in emerging markets (e.g., Basel II and SMEs)

International standards may be largely unrelated to the financial sector challenges of emerging markets (efficiency, completeness, deepness, etc.)

12

2323

2. The Negative Consequences of 2. The Negative Consequences of Excessive Government InterventionExcessive Government Intervention

2424

The main cause for the Argentine banking crisis was The main cause for the Argentine banking crisis was the Government appropriation of banking resources the Government appropriation of banking resources to finance its deficit.to finance its deficit.

This resulted in generalized fear that banks would be This resulted in generalized fear that banks would be rendered insolvent by government policy and that rendered insolvent by government policy and that deposits would be confiscated. deposits would be confiscated.

An important reason behind this fear was the fact An important reason behind this fear was the fact that that privateprivate sector sector assetsassets werewere beingbeingdisplaced by displaced by publicpublic sector sector assetsassets in in bankbank’’ssbalance sheets.balance sheets.

13

2525

0%

20%

40%

60%

80%

100%

Dec-99 May-00 Oct-00 Mar-01 Aug-01 Jan-02 Jun-02

Public Sector Private Sector

ARGENTINA: Private Sector assets are displaced by Public Sector assets in bank’s

balance sheets

$ 76 MM

$ 43 MM

2626

TheThe increasingincreasing bankingbanking exposureexposure totothethe publicpublic sector sector waswas accompaniedaccompanied

by:by:

1. a 1. a rapidrapid decreasedecrease in in depositsdeposits and and

2. a 2. a sharpsharp increaseincrease in country in country riskrisk

14

2727

71

151

104

216

80

100

60

100

140

180

220

dic-98 jun-99 dic-99 jun-00 dic-00 jun-01 dic-01

70

80

90

100

110

Indice EMBI ArgentinaCrédito al Sector Público / Patrimonio Neto (en %)Depósitos Sector Privado - Base dic2000 = 100 (2º eje)

Public Sector Loans (%)

EMBI Index

Deposits

2828

TheThe DeteriorationDeterioration in in thethe BankBank’’s Balance Sheets Balance SheetDecember 2001– December 2002

Loans to the Public Sector

21% 54%

17% 45%

0

20

40

60

80

100

120

140

160

180

Dec 01 Dec 02

Loans to Private Sector

15

2929

3.3. The Importance of Proper The Importance of Proper Liquidity ManagementLiquidity Management

Availability of liquidity is a crucial Availability of liquidity is a crucial element in the prevention and the element in the prevention and the management of financial crisesmanagement of financial crises

LOLR does not guarantee stability but LOLR does not guarantee stability but its absence accelerates the erosion its absence accelerates the erosion of confidenceof confidence

3030

Accumulated evolut ion (31-Jan-02 al 24-Jul-02)-In billion of pesos-

0

5

10

15

20

25

31-Ene 17-Feb 6-Mar 23-Mar 9-Abr 26-Abr 13-May 30-May 16-Jun 3-Jul 20-Jul

Loans Assistance Bank Reserves fall Deposits fall

The central bank provided rediscounts to illiquid The central bank provided rediscounts to illiquid banks and financed about 1/3 of the deposit dropbanks and financed about 1/3 of the deposit drop

16

3131

Initially deposit withdrawals continuedInitially deposit withdrawals continued

Private Sector Deposits - Year 2002

-2609

-4335 -4378 -4526

-998

160

-235 -340-823 -810

-1274 -1230

-5000

-4000

-3000

-2000

-1000

0

1000

Feb Mar Abr May Jun JulIn million of pesos

Deposits minus preventive measures Preventive measures

3232

However, the trend reversed after four However, the trend reversed after four monthsmonths

Private Sector Deposits - Year 2002

-2609

-4335 -4378 -4526

-998

160

-235 -340-823 -810

-1274 -1230

-5000

-4000

-3000

-2000

-1000

0

1000

Feb Mar Abr May Jun JulIn million of pesos

Deposits minus preventive measures Preventive measures

17

3333

Private Sector Deposits

40

45

50

55

60

65

70

75

80

01-Oct-01 27-Nov-01 23-Jan-02 21-Mar-02 17-May-02 13-Jul-02 18-Oct-02 04-Nov-02 31-Dec-02

Devaluation

Recovery

Pesification

3434

j

29%29%

61%52%

31%29%

-500

0

500

1,000

1,500

Ene Feb Mar Abr May Jun Jul Ago Sep Oct Nov

Millones de Pesos

-30%

0%

30%

60%

90%

Asistencia Neta Mensual Asistencia/Salida de Depósitos

Central Bank Net LiquidityCentral Bank Net LiquidityAssistance Assistance -- MonthlyMonthly

18

Fuente:IndecFuente:Indec

Total GDPTotal GDPQuarterlyQuarterly –– SeasonallySeasonally AdjustedAdjusted

220

230

240

250

260

270

280

290

300

I98 II98 III98 IV98 I99 II99 III99 IV99 I00 II00 III00 IV00 I01 II01 III01 IV01 I02 II02 III02 IV02 I03 II03 III03 IV03

Fuente: Universidad Di TellaFuente: Universidad Di Tella

ConsumersConsumers andand BusinessBusiness CONFIDENCE CONFIDENCE

25.0

30.0

35.0

40.0

45.0

50.0

55.0

Dic '99 M ar '00 Jun '00 Sep '00 Dic '00 M ar '01 Jun '01 Sep '01 Dic '01 M ar '02 Jun '02 Sep '02 Dic '02 M ar '03 Jun '03

CONSUMERS

BUSINESS

19

3737

4.4. The Role of Foreign BanksThe Role of Foreign Banks

---- Do they reduce financial Do they reduce financial vulnerability?vulnerability?

---- Can they provide, implicitly, LOLR Can they provide, implicitly, LOLR function? function?

3838

5.5. The The ““CurrencyCurrency”” ProblemProblem

20

3939

Financial vulnerability arises from the Financial vulnerability arises from the publicpublic’’s reticence to use domestic s reticence to use domestic currency as a store of valuecurrency as a store of value

---- TradeTrade--off between shallow financial off between shallow financial intermediation and financial intermediation and financial dollarizationdollarization and the risks of and the risks of balance balance sheet mismatchessheet mismatches

---- The The ““original sinoriginal sin”” is not such but just is not such but just a corollary of the currency problem a corollary of the currency problem

4040

If full If full dollarizationdollarization is ruled out, the is ruled out, the policy question to reduce policy question to reduce vulnerabilities is how to solve the vulnerabilities is how to solve the ““currencycurrency”” problem.problem.

---- ““PesificationPesification”” a laa la ArgentinaArgentina

---- Macroeconomic and Institutional Macroeconomic and Institutional Credibility and Credibility and –– in the transition: in the transition: IndexationIndexation

21

4141

If FX deposits are significant, then central If FX deposits are significant, then central bank should hold large international bank should hold large international reserves (as a share of FX deposits) reserves (as a share of FX deposits) and/or banksand/or banks’’ reserve requirements reserve requirements should be high.should be high.A complementary strategy is to give A complementary strategy is to give incentives for banks to increase local incentives for banks to increase local currency deposits by, for example, currency deposits by, for example, lowering their reserve requirements lowering their reserve requirements relative to FX deposits.relative to FX deposits.

4242

6.6. Capital ControlsCapital Controls

Does capital account integration reduce Does capital account integration reduce financial vulnerability?financial vulnerability?

Long run desirability vs. short run, Long run desirability vs. short run, transitional, riskstransitional, risks

Capital controls and crisis managementCapital controls and crisis management

22

4343

Other Issues

The Role Public Sector BankingThe Role Public Sector Banking

The Location and Structure of the The Location and Structure of the Prudential Supervision AuthoritiesPrudential Supervision Authorities

Central Bank IndependenceCentral Bank Independence