Download Sudden Stops

Banking Crises and Sudden Stops
in Latin America
Alejandro Izquierdo, IADB
IADB-Atlanta Fed Conference,
September 30, 2005
Credit Volatility
Credit in LAC is highly volatile ...
Credit Volatility
...credit volatility is related to an underdeveloped financial
sector.
Recurring Banking Crises
– LAC is the region of the world with the highest banking
crisis recurrence
– To what extent are these crises linked to external
financial conditions?
External Financial Conditions
(EMBI sovereign spread & Current Account Balance in EMs,
millions of USD, last four quarters)
Tequila
Crisis
150000
Asian
Crisis
Russian
Crisis
2500
100000
50000
1500
0
1000
-50000
500
-100000
Jan-04
Jul-03
Jan-03
Jul-02
Jan-02
Jul-01
Jan-01
Jul-00
Jan-00
Jul-99
Jan-99
Jul-98
Jan-98
Jul-97
Jan-97
Jul-96
Jan-96
Jul-95
Jan-95
Jul-94
Jan-94
Jul-93
Jan-93
Jul-92
Jan-92
Jul-91
0
Jan-91
-150000
– A largely unexpected shock forced closure of current
account deficits
EMBI spread (basis points)
2000
Sudden Stops: Bunching
7
6
Emerging Markets
Developed Economies
5
4
3
2
1
0
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
–Triggering Factor, or incipient Sudden Stop, is most likely
external
Crisis and Volatility: Twin Crises
– This is highly relevant for the banking sector considering
that sudden stops and banking crises are another set of
twins (75% in dollarized countries)
Sudden Stops
and Large Depreciation
In % of total
Emerging
Markets
Developed
Economies
Depreciations associated with Sudden Stop
Of which: First Sudden Stop, then depreciation
First depreciation, then Sudden Stop
63
42
21
17
9
9
Depreciations not associated with Sudden Stop
37
83
Note: The total number of large devaluations is 19 in emerging markets and 23 in developed
economies.
– A key element behind this twin relationship is the fact that,
for EMS, real currency depreciation is associated about
two thirds of the time with Sudden Stops
Sudden Stop and
Size of Depreciation
 Bringing the current account deficit to balance
implies a forced adjustment in demand of
tradable goods
 When the supply of tradable goods is small
(relative to absorption of tradables), relative
prices must do most of the work (so that
tradables are sufficiently expensive to reach
the new equilibrium).
 CAD/A=(Y*-S)/A=w
Crisis and Volatility: Sudden Stops
– Even if the trigger is external, the probability of a full
fledged sudden stop depends on the interaction between:
w (capturing potential changes in RER), and
the degree of banking dollarization (as a share of GDP)
Crisis and Volatility
– This is particularly relevant for LAC because
dollarization levels are relatively high...
Crisis and Volatility:
Currency Mismatches
– mismatches are high...
Crisis and Volatility
... and public sector debt holdings are high, particularly in
larger countries
– Public debt is highly dollarized: Governments are part of the
problem and cannot secure bailouts with fiscal solvency
Bank Runs and Crisis Resolution
• In fear that a Sudden
Stop is imminent,
depositors will have
incentives to run
when bank portfolios
consist of unhedged
dollar loans and
public bonds.
• In contrast to
developed countries,
inadequate resolution
of crises in LAC
(where depositors
pay for the crises)
may have increased
the volatility of
deposits.
Summary
• Large RER fluctuations and SS are mainly an EM
phenomenon.
• SS seem to come in bunches.
• SS and banking crises are a set of twins.
• Openness (un-leveraged absorption of tradables) and liability
dollarization heavily influence the probability of a SS.
• High levels of current account leverage and financial
dollarization could become a dangerous cocktail.
• Both are the result of a stream of past domestic policies, very
difficult to reverse in the short run.
Policy Agenda: Bank Level
– Dealing with domestic liability dollarization to reduce
the likelihood of twin crises:
• Regulation in the banking system for appropriate
treatment of credit risk of dollar loans and
government debt:
– Price to market
– Provisions
– Capital adequacy ratios
– Hedging
• Creation of hedging markets.
Policy Agenda: Macro Level
– Reducing liability dollarization:
• increasing central bank independence (low inflation volatility
and the reduction of fiscal pressures)
• introducing sound alternatives to dollar assets, such as CPIindexed instruments
– Facing sudden stops with a pre-announced monetary
policy that increases credibility of monetary policy
(Caballero)
– Crisis resolution processes must ensure that the parties
that took higher risk bear the brunt of the costs
Policy Agenda: Global Level
– Trade integration to enhance export price elasticity
in case of financial stress (reducing RER effects).
– Global Lender of Last Resort. For example,
Emerging Market Fund, EMF, to stabilize EMBI
(Calvo).
Banking Crises and Sudden Stops
in Latin America
Alejandro Izquierdo, IADB
IADB-Atlanta Fed Conference,
September 30, 2005