Steven R. Weisbrod

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.

Asset Price Inflation in the 1980's; A Flow of Funds Perspective

This paper examines how and why financial resources were channeled almost exclusively to specific asset markets in Japan, the United Kingdom, and the United States in the late 1980s. A decline in demand for funds by traditional borrowers, and a shift by savers from banks toward indirect securities investments were critical factors in all three cases. Until intermediaries and investors learned to evaluate new opportunities, funds were recycled in certain asset markets. The pressures on Japanese asset markets were particularly intense because of the size of Japan`s domestic saving relative to traditional domestic investment opportunities.

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.

Towards an Effective Regulatory and Supervisory Framework for Latin America

This paper raises fundamental questions about how banks in Latin America ought to be supervised. The concentration of wealth holders in Latin America and the equity markets` resulting illiquidity permit investors who control banks to subvert the intent of capital requirements, even when the bank itself is subject to rigorous accounting standards. A number of policy implications follow from the analysis. Three of policy recommendations derived from this analysis can be successfully implemented in the short run. Latin American supervisors should focus on: improving the markets that already work in Latin America, which currently are markets for bank liabilities; severely limiting public safety nets for bank liabilities so that risky banks face a high price for raising liabilities; and encouraging macroeconomic policies to play a much more important role in restraining bank risk in Latin America than in the industrial countries.

2 - Supervision and Regulation of Financial Markets in the New Financial Environment

Publisher Summary This chapter discusses the supervision and regulation of financial markets in the new financial environment. Recent developments in world financial markets, in particular the liberalization of cross-border financial transactions and the restructuring of domestic financial institutions in some major industrial countries, have profoundly altered the environment in which central bank supervisory and regulatory policy is made. In broad terms, the central banks financial policy seeks to achieve an efficient allocation of capital resources and to limit the real effects of financial disturbances, that is, of liquidity crises. The chapter further discusses the main sources of systemic disturbances and presents the central banks policy paradigm. In particular, regulations can be designed so that disturbances from the non-payments activities of banks do not spill over into the payments system and become systemic. Such regulations include risk-related capital requirements, separation of investment banking activity from payments activity, position limits, and assessment of the solvency of the bank through supervision and inspection of the banks assets.

Financial Markets and the Behavior of Private Savings in Latin America

This paper complements previous studies by arguing that the low private savings ratio in Latin America can be associated with the limited confidence of households and businesses in domestic financial institutions. Previous studies have established a relationship between private savings and financial markets either by using a measure of `financial depth` or a measure of `borrowing constraints. ` This paper offers an alternative view by claiming that the private savings rate relates positively to the confidence of the private sector in the strength of the financial system and that the latter concept can be approximated by the ratio of corporate demand for bank liquid assets. Latin American countries have lower private savings rates than other developing and most industrial countries. They also display the highest corporate to household bank deposit ratios among the three groups of countries considered here. Further, the ratio of corporate to household deposit holdings is strongly correlated with other indicators of banking system fragility.