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Global Financial Regulatory Reform: Implications
for Latin America and the Caribbean (LAC)
Robert Rennhack
Assistant Director
Western Hemisphere Departament
International Monetary Fund
October2009
1
Advanced Countries—Reasons for Reform

Financial system and global economy overexposed to risk by
current focus on close supervision of banks, combined with
market discipline and self-regulation to monitor non-banks.

Resolution strategy in several countries, including U.S., has left
financial system exposed to moral hazard.

Reforms aim to mitigate systemic risk without stifling financial
innovation through excessive and inefficient regulation.

Effective financial regulation requires strong political backing.
2
Advanced countries–Key reform priorities

Expand the perimeter of regulation by re-evaluating what is
considered a systemic institution and impose stronger regulation.

Better cross-border and cross-functional regulation.

Reduce procyclicality of regulatory and institutional practices.

Strengthen public disclosure practices for systemically important
financial institutions and markets.

Give greater flexibility to monetary policy to focus more on
credit and asset price booms.
3
Reform for LAC?—Resilience

Improved legal framework
for supervision
Capital to Assets Ratio
(in percent)
20.0
19.0
Caribbean
18.0
Other
17.0
16.0
15.0
14.0

Reasonable capital cushion
13.0
Central America
12.0
Major Latin American
countries
11.0
10.0
2000

2001
Falling nonperforming loans
2002
2003
2004
2005
2006
2007
2008
2007
2008
Nonperforming Loans
(As percent of total loans)
14.0
12.0

Solid funding base
10.0
Caribbean
Other
8.0
6.0

Relatively high returns
Major Latin American
countries
4.0
2.0
Central America
0.0
2000
2001
2002
2003
2004
2005
2006
4
Broader Regulatory Perimeter


Strong regulation should apply to any financial
institution, not just banks, that can threaten the
financial system.
Systemic institution—interconnected, such as:

any large financial institution (including off-balance sheet items);

key role in the financial infrastructure:

high leverage;

group of small financial institutions that may be collectively systemic if
they move together during a crisis; or
5
Broader Regulatory Perimeter

In most LAC countries, potential for systemic risk from
many non-bank financial institutions





insurance companies;
financial conglomerates;
cooperatives;
investment and mutual funds;
retail chains (such as supermarkets) that issue credit cards.
Broader Regulatory Perimeter—Policy
Options

Improve methodologies for assessing systemic risks.

Systemic institutions would face tougher norms, such as for
capital adequacy, leverage and liquidity, to contain moral hazard.

Single systemic risk regulator?

Lighter touch for non-systemic institutions to foster innovation.

Example, subject hedge funds to registration and disclosure
requirements.
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7
More effective consolidated supervision

Supervisors could not see links among financial institutions and
instruments.

Especially for large complex financial institutions that operated
in many different financial markets and countries.

These institutions tended to operate under the least intrusive
regulations available.
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More effective consolidated supervision

In the LAC region, many countries have strengthened their legal
frameworks for consolidated supervision.

However, supervisors often cannot:
 monitor all institutions; and
 enforce regulations and require prompt corrective action for
all institutions within a conglomerate.

Cross-border supervision also matters in many countries, where
international banks have a significant presence.
9
More effective consolidated supervision

Apply prudential requirements to all parts of a financial group,
not just some of the individual affiliates.

Mandate exchange of information and create institutional
mechanisms to build closer cooperation.

Form cross-country regulatory colleges to deal with global
banks—full information sharing, harmonization of norms
across countries and a clear assignment of responsibilities.
10
Reduce Procyclicality

Features of regulatory frameworks may have exacerbated
excessive credit growth pre-crisis and rapid deleveraging.

Possible culprits:



Capital adequacy guidelines under Pillar 1 of the Basel II
framework.
Loan loss provisioning linked to the payment history on
loans.
Fair value accounting (FVA) or “mark to market”.
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Reduce Procyclicality

In much of the LAC region
Credit Growth to the Private Sector
(In percent)
40

Backward-looking loan loss
provisions.
Other
35
Central America
30
25
20

Use of collateral-based lending.
Major Latin American
countries
15
10

Basel II capital adequacy
requirements.
Caribbean
5
0
-5
2000

Use of FVA.
2001
2002
2003
2004
2005
2006
2007
2008
Reduce Procyclicality—Policy Options

Make capital adequacy requirements countercyclical—
adjustments of capital charges; issue convertible debt.

Introduce dynamic provisioning requirements, as in Spain,
Bolivia, Colombia, Peru and Uruguay;

Retain FVA but with buffers, limited flexibility.
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13
Improve Information

In advanced countries, poor understanding of risk exposures and
linkages across borders and markets of financial institutions.

In LAC region,

Little or no reporting of off-balance sheet operations of
banks; transactions by the non-bank affiliates of a financial
conglomerate; or the activities of lightly regulated non-banks.

Poor information on macrofinancial linkages.
14
Improve Information

Develop much better information on the linkages between
macroeconomic developments and the financial sector.

Stronger public disclosure by systemic financial institutions.

For countries moving toward the Basel II prudential framework,
systemic financial institutions need to disclose their risk
management practices and models used to value risk.

Improve the transparency of derivative markets and require
exchange trading of derivatives (Chile, Colombia, Mexico).
15
Role of Global Banks
Foreign Banks' Lending as a Share of GDP, 2008 1/
(Percent)

Effect of tougher prudential
norms in home country?
70
60
50
40
30
20
10
Asia emergente
África y Medio Oriente
Europa emergente
Bolivia
Ecuador
Venezuela
Colombia
Argentina
Brasil
Uruguay
Perú
Paraguay
Amplify or dampen effects
of global crisis?
República Dominicana

México
0
Costa Rica
Optimal share of banking
system?
Chile

Sources: Bank for International Settlements; and IMF staff calculations.
1/ Includes cross-border lending and lending by foreign-owned local affiliates
in each country.
Note: Regional data correspond to the median across countries.
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Reform for LAC?

Look closely at steps to broaden the regulatory perimeter.

Improve consolidated supervision

Reduce procylicality of prudential regulations may be advisable.

Strengthen public disclosure of information.

Move cautiously on broader mandate for monetary policy.
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Thank you for your attention