Liliana Rojas-Suarez

Liberalization of the Capital Account: Experiences and Issues

This paper reviews the experience with capital controls in industrial and developing countries, considers the policy issues raised when the effectiveness of capital controls diminishes, examines the medium-term benefits and costs of an open capital account, and analyzes the policy measures that could help sustain capital account convertibility. As the effectiveness of capital controls eroded more rapidly in the 1980s than in earlier periods, new constraints were placed on the formulation of stabilization and structural reform programs. However, experience suggests that certain macroeconomic, financial, and risk management policies would allow countries to attain the benefits of capital account convertibility and reduce the financial risks created by an open capital account.

Determinants and Systemic Consequences of International Capital Flows

The growing integration of capital markets has strengthened incentives for greater international coordination of economic and financial policies. Structural changes in these financial market, however, may have undermined the effectiveness of monetary and fiscal policy and complicated market access by developing countries. These are among the findings of this study of capital flows in the 1970s and the 1980s.

Financial Market Fragilities in Latin America: From Banking Crisis Resolution to Current Policy Challenges

This paper has two objectives: first, by reviewing the recent experience of five Latin American countries with the restructuring of their financial sectors, it derives lessons regarding the most effective ways to resolve banking difficulties in developing countries. Second, the paper analyzes current policy challenges associated with the health of financial systems in Latin America, including: (a) designing policies to respond to the recent large inflows of capital that maintain long-run macroeconomic stability and healthy financial systems; and (b) evaluating the impact of capital markets competition on the soundness of banking systems.

Building Stability in Latin American Financial Markets

This paper argues that the investor reluctance to make long-term commitments to Latin American financial markets results from experience. In the 1980s, while ex ante real interest rates on Latin American financial assets were usually high, ex-post real interest rates were often highly negative. In the 1990s, policymakers instituted stabilization programs and structural reforms that have improved the environment in which financial markets operate. Based on a review of experiences in the region, this paper shows that, when these opportunities are taken, investor confidence in long-term markets is strengthened.

Financial Integration and Foreign Banks in Latin America: How Do They Impact the Transmission of External Financial Shocks?

This paper explores the impact of international financial integration on credit markets in Latin America, using a cross-country dataset covering 17 countries between 1996 and 2008. It is found that financial integration amplifies the impact of international financial shocks on aggregate credit and interest rate fluctuations. Nonetheless, the net impact of integration on deepening credit markets dominates for the large majority of states of nature. The paper also uses a detailed bank-level dataset that covers more than 500 banks for a similar time period to explore the role of financial integrationcaptured through the participation of foreign banksin propagating external shocks. It is found that interest rates charged and loans supplied by foreign-owned banks respond more to external financial shocks than those supplied by domestically owned banks. This does not hold for all foreign banks. Spanish banks in the sample behave more like domestic banks and do not amplify the impact of foreign shocks on credit and interest rates.

The Provision of Banking Services in Latin America: Obstacles and Recommendations

The depth of and access to financial services provided by banks throughout Latin America are extremely low in spite of its recognized importance for economic activity, employment and poverty alleviation. Low financial depth and access hurts the poor the most and is due to a variety of obstacles that are presented in this paper in four categories, along with recommendations to overcome them. The first category groups socio-economic obstacles that undercut the demand for financial services of large segments of the population. The second category identifies problems in the operations of the banking sector that impedes the adequate provision of financial services to households and firms. The third category captures institutional deficiencies, with emphasis on the quality of the legal framework and the governability of the countries in the region. The fourth category identifies regulations that tend to distort the provision of banking services. Recommendations to confront these obstacles include innovative proposals that take into consideration the political constraints facing individual countries. Some of the policy recommendations include: public-private partnerships to improve financial literacy, the creation of juries specialized in commercial activities to support the rights of borrowers and creditors, and the approval of regulation to allow widespread usage of technological innovations to permit low-income families and small firms to gain access to financial services.

Bank Risk and the Declining Franchise Value of the Banking Systems in the United States and Japan

This paper associates both the increase in risk taken by wholesale banks in the United States and the decline in earnings at wholesale banks in Japan with a reduction in the franchise value of wholesale banking. In contrast with the conventional view that relates the franchise value of banking to informational advantages over other lenders, this paper argues that banks’ franchise value originates in their provision of liquidity and payments services to their customers. Therefore, the decline in corporate demand for bank liquidity is identified as a major factor explaining the fall of the franchise value. The paper also analyzes recent proposals for banking reform and assesses their relevance for dealing with the problems of wholesale banks.

Interest Rates in Mexico: The Role of Exchange Rate Expectations and International Creditworthiness

The link is explored between interest rates on domestic financial assets in Mexico and expectations of exchange rate changes and perceptions about default risks contained in Mexicos external debt. Interest rate differentials between peso- and U.S. dollar-denominated assets are shown to have reflected concerns about the exchange rate policy during the period considered. The evidence also suggests that the interest rate on a U.S. dollardenominated Mexican domestic asset is linked to the yield implicit in the secondary market price for external debt issued by Mexico.

The International Financial Crisis: Eight Lessons for and from Latin America

The international financial crisis of 2008–09 exposed the strengths and weaknesses of the current paradigm of development in Latin America, a paradigm based on liberalized capital accounts and significantly improved macroeconomic conditions. This paper presents lessons derived from the crisis, not only for the region itself, but also for other developing countries that might seek economic growth in the context of greater integration to the international capital markets. Some of the lessons are not new but have been reinforced by the crisis, such as Latin America’s imperative need for export diversification (not only in products but in partners). Other lessons break with longstanding myths about the region, such as its inability to undertake counter-cyclical policies—at least on the monetary side. Yet other lessons reflect new developments in the current growth paradigm, such as a renewed assessment of (1) the relative roles of foreign and domestic banks in shielding the financial system against external shocks and (2) the desirability of adopting blanket international financial regulations that do not account for a country’s degree of development. Taken together, the lessons in this paper bring a new sense of optimism for growth in Latin America.

Financial Regulations in Developing Countries: Can they Effectively Limit the Impact of Capital Account Volatility?

This paper identifies two alternative forms of prudential regulation. The first set is formed by regulations that directly control financial aggregates, such as liquidity expansion and credit growth. An example is capital requirements as currently incorporated in internationally accepted standards; namely capital requirements with risk categories used in industrial countries. The second set, which can be identified as the “pricing-risk-right” approach, works by providing incentives to financial institutions to avoid excessive risk-taking activities. A key feature of this set of regulations is that they encourage financial institutions to internalize the costs associated with the particular risks of the environment where they operate. Regulations in this category include ex-ante risk-based provisioning rules and capital requirements that take into account the risk features particular to developing countries. This category also includes incentives for enhancing market discipline as a way to differentiate risk-taking behavior between financial institutions. The main finding of the paper is that the first set of regulations—the most commonly used in developing economies-- have had very limited usefulness in helping countries to contain the risks involved with more liberalized financial systems. The main reason for this disappointing result is that, by not taking into account the particular characteristics of financial markets in developing countries, these regulations cannot effectively control excessive risk taking by financial institutions. Moreover, the paper shows that, contrary to policy intentions, this set of prudential regulations can exacerbate rather than decrease financial sector fragility, especially in episodes of sudden reversal of capital flows. In contrast, the paper claims, the second set of prudential regulation can go a long way in helping developing countries achieving their goals. The paper advances suggestions for the sequencing of implementation of these regulations for different groups of countries.