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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
                                                                   Capital to Assets Ratio
                                                                                 (in percent)

   Improved legal framework      20.0
                                  19.0                                                                         Caribbean


    for supervision               18.0
                                  17.0
                                                          Other

                                  16.0
                                  15.0
                                  14.0



    Reasonable capital cushion
                                  13.0


                                                                                                     Central America
                                  12.0
                                                    Major Latin American
                                  11.0                    countries
                                  10.0
                                         2000       2001        2002       2003         2004     2005      2006      2007     2008




   Falling nonperforming loans                                        Nonperf orming Loans
                                                                  (As percent of total loans)

                                    14.0


                                    12.0



   Solid funding base              10.0

                                                                               Other
                                                                                                         Caribbean


                                     8.0


                                     6.0

                                                  Major Latin American
                                     4.0

    Relatively high returns
                                                         countries

                                    2.0
                                                                Central America
                                     0.0
                                           2000        2001       2002       2003         2004    2005      2006       2007   2008
                                                                                     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.
                                                                         6

    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.
                                                                        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.
                                                                      8


    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”.
                                                                                                                                11


                    Reduce Procyclicality

   In much of the LAC region                                Credit Growth to the Priv ate Sector

                                                                                (In percent)

                                            40

                                                                                                      Other

        Backward-looking loan loss         35

                                                                               Central America

         provisions.                        30


                                            25
                                                    Major Latin American
                                                         countries
                                            20

        Use of collateral-based lending.   15


                                            10



         Basel II capital adequacy
                                                                                                      Caribbean
     
                                             5



         requirements.                       0


                                            -5

                                             2000     2001       2002      2003      2004      2005      2006     2007   2008



        Use of FVA.
                                                                12

    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.
                                                                           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   70


    norms in home country?
                                   60

                                   50
                                   40

                                   30

   Optimal share of banking       20


    system?
                                   10

                                    0




                                                             México




                                                                                                                                                                               Bolivia
                                                Costa Rica




                                                                                                                                                                                                                                     Asia emergente
                                                                                       República Dominicana




                                                                                                                                                                                                            África y Medio Oriente
                                                                                                                                              Colombia
                                                                                                                                                         Venezuela




                                                                                                                                                                                         Europa emergente
                                                                                                              Brasil
                                        Chile




                                                                                                                                  Argentina
                                                                      Perú
                                                                             Uruguay




                                                                                                                                                                     Ecuador
                                                                                                                       Paraguay
   Amplify or dampen effects of
    global crisis?
                                     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.
                                                                       16


                    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.
                               17




Thank you for your attention

				
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