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She is also the chair of the Latin American Shadow Financial Regulatory Committee (CLAAF). From March 1998 to October 2000, she served as managing director and chief economist for Latin America at Deutsche Bank. Before joining Deutsche Bank, Rojas-Suarez was the principal advisor in the Office of Chief Economist at the Inter-American Development Bank. Between 1984-1994 she held various positions at the International Monetary Fund, most recently as deputy chief of the Capital Markets and Financial Studies Division of the Research Department. She has been a visiting fellow at the Institute for International Economics, a visiting advisor at the Bank for International Settlements and has also served as a professor at Anahuac University in Mexico and advisor for PEMEX, Mexico’s National Petroleum Company. Rojas-Suarez has also testified before a Joint Committee of the US Senate on the issue of dollarization in Latin America.
She has published widely in the areas of macroeconomic policy, international economics and financial markets in a large number of academic and other journals including Journal of International Economics, Journal of International Money and Finance, Journal of Development Economics, Journal of Contemporary Economic Policy, International Monetary Fund Staff Papers. She has also published or being cited in prestigious newspapers such as the Financial Times, the Wall Street Journal and the Washington Post. She is also regularly interviewed by CNN en Español.
Michael P. Dooley & Donald J. Mathieson & Liliana Rojas-Suarez, 1997. "Capital Mobility and Exchange Market Intervention in Developing Countries" NBER Working Papers 6247, National Bureau of Economic Research, Inc.
Rojas-Suarez, L & Weisbrod, S-R, 1997. "Financial Markets and the Behavior of Private Savings in Latin America" Working Papers 340, Inter-American Development Bank, Research Department.
McNelis, P.D. & Rojas-Suarez, L., 1996. "Exchange rate depreciation, Dollarization and Uncertainty: A Comparison of Bolivia and Peru" Working Papers 325, Inter-American Development Bank, Research Department.
Rojas-Suarez, L. & Weisbrod, S.R., 1996. "Banking crises in Latin America: Experience and Issues" Working Papers 321, Inter-American Development Bank, Research Department.
Rojas-Suarez, L. & Weisbrod, S.R., 1996. "Building Stability in Latin American Financial Markets" Working Papers 320, Inter-American Development Bank, Research Department.
Rojas-Suarez, L. & Weisbrod, S.R., 1996. "Managing Banking Crises in Latin America: The Di's and Don'ts of Successful Bank Restructuring Programs" Working Papers 319, Inter-American Development Bank, Research Department.
Rojas-Suarez, L. & Weisbrod, S., 1994. "Achieving Stability in Latin American Financial Markets in the Presence of Volatile Capital Flows" Working Papers 304, Inter-American Development Bank, Research Department.
This article was originally published as a guest post for IFMR Trust.
Only about half of Indian adults have access to an account of any kind. The number is even lower for the poorest 40 percent (World Bank, Global Findex 2014). Furthermore, there are only 13 commercial bank branches per 100,000 adults (IMF, Financial Access Survey 2014). Keeping in mind the low levels of financial inclusion in the country, the Indian authorities have developed a broad strategy to improve access to financial services, as outlined in the report by the Committee on Comprehensive Financial Services for Small Business and Low Income Households, led by Nachiket Mor. Among the committee’s recommendations, payments banks are one innovative tool to further India’s goal of greater financial inclusion.
Payments banks are different from regular banks. They can only accept deposits up to Rs. 1 lakh per person, roughly $1500, and cannot grant loans. Furthermore, payments banks can only invest their money in safe government securities and other highly liquid assets. Their primary objective is to further financial inclusion by providing access to small savings, payments and remittance services to low-income customers without compromising financial stability. By leveraging technology and tapping into their large networks, these banks might potentially allow millions more people, many in remote corners of India, to operate bank accounts, with often very small sums of money. In August 2015, the Reserve Bank of India (RBI) granted “in-principle” licenses to eleven entities to launch payments banks.
While it is too early to assess results, as these banks are not operational yet, a valid question is whether the regulations governing these payments banks are consistent with fundamental regulatory principles for improving financial inclusion while protecting financial stability and integrity. To answer this question, I compare key characteristics of the payments banks against major recommendations in the recently released report, Financial Regulations for Improving Financial Inclusion, by the CGD Task Force on Regulatory Standards for Financial Inclusion. The report advances three major recommendations (among others) for expanding financial inclusion in a safe and sound manner:
Encourage competition by allowing new and qualified providers to enter the market
Create a level playing field between different providers by making the regulatory burden proportional to the risk posed by providers to individual customers and the overall stability of the financial system
Apply risk-proportionate Know-Your-Customer (KYC) rules to balance financial integrity and financial inclusion
How do India’s payments banks measure against these recommendations?
Enhancing Competition among Providers of Financial Services
Payments banks certainly encourage the entry of new, qualified and innovative players. The entities licensed to become payments banks encompass a broad range of sectors, including telecommunications, finance and banking, IT, and postal services. The first payments bank is expected to be operational by the end of this financial year.
The licensing of payments banks is contingent upon various players meeting the appropriate entry criteria. The approved entities need to have a solid track record and ability to conform to the highest standards of service. More details about the licensing process can be found here. A thorough regulatory and licensing regime is crucial for financial stability. After all, India’s experience with expanding rural banks in 1976 without a proper regulatory framework ended in huge losses in 1991. India’s clear licensing requirements for payments banks are consistent with the CGD report’s recommendation to encourage entry of a wide variety of qualified providers of financial services. Of course, given the restrictions on payment banks’ activities, the implications of “fit and proper” are quite different for these banks compared to traditional banks.
Leveling the Playing Field between Providers of Financial Services
Since payments banks do not undertake credit risk, the RBI has stipulated a minimum capital requirement of Rs. 100 crore ($15 Mn) for payments banks (among other requirements), unlike traditional banks that must meet a capital requirement of Rs. 500 crore ($75 Mn). As these payments banks assume lower risk, it only makes sense that they have to carry a lower regulatory burden.
However, if the entities licensed to become payments banks wish to expand their activities beyond those allowed for payments banks, they would need to be licensed to become full-service banks. Similarly, if the payments bank reaches a net worth of Rs. 500 crore and becomes critical to the stability of the financial system, diversified ownership will be mandatory within three years. Such a risk-based approach is essential to ensure a balance between fostering innovative financial services and ensuring the safety and soundness of the financial system, as recommended in the CGD report.
Applying Know-Your-Customer (KYC) Rules
India has already encouraged improvement in financial access as well as up-take of national ID (Aadhaar) by allowing people to open restricted bank accounts subject to later showing proof of identity. These restricted bank accounts have limits on balances and activities. Similarly, simplified KYC requirements would be applied to “small accounts” transactions through payments banks. Payments banks are expected to encourage the expansion of these types of “small accounts” through their extensive networks. Furthermore, Aadhaar will play a key role in facilitating the take-up of “small accounts” with simplified risk-based KYC processes, as recommended in the CGD report.
While there is no one-size-fits-all solution to improve financial inclusion, there are important lessons to be learned from India’s step to approve payments banks. After India’s previous experiments with different efforts to improve financial inclusion, payments banks offer one promising way towards better financial access. India’s forward-looking vision to leverage digital finance combined with innovation-friendly regulations could pave way for a bright and safe future for payments banks.
The rise of digital technology has nurtured a growing industry around the world in financial services that benefit the poor, from mobile payments and money transfers to micro-savings and mobile-based crop insurance. But as the financial landscape evolves to include these disruptive innovations, new players and new business models could bring fresh risks to individual users and to financial systems. So how should policymakers respond?
Does broadening financial access to large segments of the population pose risks to financial stability? Not necessarily, according to recent remarks by IMF managing director Christine Lagarde. Increasing access to basic financial transactions such as payments does not threaten financial stability, especially when appropriate supervisory and regulatory frameworks are in place. In fact, with the right regulatory supervision, increased access to financial services can result in both micro and macro benefits. Recognizing the macroeconomic and regulatory dimensions of financial inclusion, CGD and the IMF joined forces for a seminar to kick off the IMF Spring Meetings 2016.
Both CGD and the IMF have been actively engaged in rigorous research centered on financial inclusion. CGD recently published a report on how regulation can improve financial inclusion. The IMF has produced a study investigating the linkages between financial inclusion and macroeconomic benefits. The seminar provided a unique opportunity for the merger of these two areas of expertise.
While there is clear micro-level evidence for the benefits of financial inclusion in improving the daily lives of large segments of the population, the evidence for macro benefits of financial inclusion has been less clear. Lagarde’s opening remarks highlighted the main question motivating the first panel: is the concept of financial inclusion even macro-relevant? In other words, does increasing access to financial services make a difference at the national or global level? In short, yes. Previous evidence by the IMF has shown that inclusive growth could lead to tangible macroeconomic benefits, such as higher GDP and lower income inequality.
Watch Christine Lagarde’s comments on the macroeconomic benefits of financial inclusion from 6:30-8:17 in this video.
What is less clear is the link between financial inclusion and financial stability with respect to credit access. Credit can play a crucial role in helping the poor cope with poverty. However, unchecked credit access could also harm financial stability. The 2010 microfinance crisis in Andhra Pradesh, India is often cited as the prime example of such an instance. However, appropriate regulations and checks are critical to ensure that financial stability is preserved as credit access is broadened. In fact, Lagarde noted in her opening remarks: “Using information on supervisory quality in about 100 countries from the Financial Sector Assessment Program, we find that when supervision is of high quality, broadening credit access actually leads to an increase in financial stability.”
Watch Subir Gokarn and Aslı Demirgüç-Kunt discuss the risks of broadening credit access from 43:19-46:00 in this video.
The first panel also tackled ways to lower barriers to financial inclusion for traditionally marginalized groups, particularly women. Despite broad advances in improving access to basic financial services, the male-female financial inclusion gap has remained persistent. IMF’s Subir Gokarn and Gates Foundation’s Gargee Ghosh highlighted the role of attitudes and trust as key barriers to the uptake of financial services by marginalized customers. Product design is crucial to overcome such behavioral biases and to ensure that financial products are catered to the particular needs of consumers (also discussed in this CGD blog post). While the panel talked about the role of financial literacy and branchless banking in addressing some of the barriers faced by women, IMF’s Ratna Sahay went a step further, emphasizing a bolder approach to address the gender gap and recommended greater involvement of women in the supply side as financial services providers.
Watch Ratna Sahay discuss ways to reduce the gender gap in financial inclusion from 56:32-58:13 in this video.
Photo by IMF
The second panel kicked off with an opening presentation by CGD senior fellow Liliana Rojas-Suarez on the recently published CGD report on regulations for improving financial inclusion. Her presentation laid down the key principles and areas of focus for regulatory improvement to further financial inclusion without compromising financial regulators’ traditional mandates of stability, integrity, and consumer protection. The discussion of financial inclusion as a key policy objective alongside the traditional mandates of regulators is a big step forward in itself.
Watch Liliana Rojas-Suarez present CGD’s recent report on how regulations can improve financial inclusion from 7:05-9:54 in this video.
Any conversation about financial inclusion is incomplete without discussing the role of technology. Digital advances have played a major role in expanding financial services to previously underserved sections of the population. However, they have also introduced new risks through new products, players, and models. One important challenge for regulators is to not fall behind the technological curve, as noted by Nicola Véron, senior fellow at Bruegel. However, at the same time, regulators have to be cautious about not regulating prematurely, which could stifle innovation. The CGD report recommends striking a balance between ex ante and ex post regulations, where clear rules are specified ex ante but with the option for ex post intervention as services and providers evolve.
Watch Stijn Claessens talk about how to strike a balance between ex post and ex ante regulation from 27:13-29:00 in this video.
In line with another recommendation from CGD’s report, the panelists emphasized the need for greater coordination between different regulatory and supervisory agencies, both financial and non-financial ones. Tim Adams, president of the Institute of International Finance, pointed out that there is enormous fragmentation in the regulatory and supervisory space. Echoing these concerns, Tilman Ehrbeck, partner at Omidyar Network, took note that we are unlikely to see movement in the Anti-Money Laundering/Combating the Financing of Terrorism (AML/CFT) space until the regulatory and supervisory jurisdictions are in alignment.
Watch Tim Adams and Tilman Ehrbeck discuss the need for greater coordination between regulatory and supervisory agencies from 1:08:40-1:10:15 in this video.
The event concluded with closing remarks by CGD’s Nancy Birdsall, who drew attention to how financial inclusion has come a long way. The attention towards financial inclusion in both domestic and international agendas shows the increasing recognition of financial inclusion, especially digital financial services, as a key development tool. She also underscored the importance of data, particularly real-time data to bring financial services to underserved populations. By the end of the event, it was clear that advances in financial inclusion are fast-moving due to technology and will continue to require attention in times to come. The future of financial inclusion depends on how regulators and policymakers interact with these rapid technological advances driving financial products.
Watch Nancy Birdsall’s closing remarks on the future of financial inclusion from 1:26:19-1:28:06 in this video.
Poor regulation is a key obstacle to financial inclusion. An enabling regulatory environment is critical for creating incentives for businesses to offer innovative financial services to the poor, and for underserved customers to take up formal financial services.
While new technologies have broadened access to financial services among the poor, they have also introduced new risks. The primary challenge for regulators is to broaden financial access while ensuring financial stability, integrity and consumer protection. How can regulators balance these multiple objectives?
The topic was the center of discussion at a recent event at CGD to launch Financial Regulations for Improving Financial Inclusion, a report by the high-level CGD Task Force. The event kicked off with opening remarks from Marisa Lago, Assistant Secretary for International Markets and Development, U.S. Department of Treasury, who stressed that regulatory structures must keep pace with evolving technologies in the digital finance space to protect consumers and the financial system without suppressing innovation. “As the report rightfully indicates,” she commented, “regulations should be appropriately tailored according to risk, and in particular the risks associated with services being provided but also the scale at which they are provided.”
The keynote address was followed by a presentation by co-chair of the CGD Task Force, senior fellow Liliana Rojas-Suarez, who gave a brief overview of the framework and stressed three key principles for regulations for financial inclusion: similar regulations for providers carrying out similar activities regardless of institutional form, regulation proportional to risk imposed by the particular activity, and a balance between ex ante and ex post regulations to allow for experimentation and innovation.
How can regulators level the playing field between different forms of service providers?
Stijn Claessens, Senior Adviser to the Federal Reserve Board and the other co-chair of the Task Force, stressed the importance of a level playing field between different providers of similar services, such as banks, mobile network operators and other digital financial services providers. That essentially means the creation of a regulatory environment where similar services are treated equally, regardless of the institutional form of the provider. Basically, regulations should be tied to the risk that the provider’s activities pose to the consumers and the financial system. For example, the regulatory standard applied to a digital financial institution that only engages in small payments should be lower than the standard applied to a full-service bank. However, when the same institution starts offering bank-like services such as store-of-value and credit, the applicable regulatory standard would be higher. In a nutshell, if you act like a bank, you should be regulated like a bank.
How important is national identification for Know-Your-Customer (KYC) rules?
A unified national identification system, although an expensive goal, is important to create a financially inclusive system. In order to implement risk-based KYC procedures that expand access to financial services among the underserved while minimizing the risks of illicit fund activities, it is crucial that financial institutions have access to accurate information about consumers. CGD's Alan Gelb leads the field in research on biometric identification for development, and at the event he noted how many countries have unfortunately seen the development of multiple identification systems, which is not only costly for individual institutions but also makes "knowing your customer" harder. Njuguna Ndung'u, the former Governor of the Central Bank of Kenya, who oversaw the rollout of the hugely successful digital payment system M-Pesa, further stressed that it is not important to just have an ID, but to have a legitimate ID. Alan Gelb recommended that ID systems need to transition from identifying cards to identifying people with the help of biometric technology.
Here at CGD we will be continuing the conversation about regulatory principles to broaden financial inclusion. While there is no “one-size-fits-all” solution, as each country’s opportunities and challenges are likely to differ, we hope that the broad principles put forward in this report can serve as a guiding tool for countries seeking to expand financial services to traditionally excluded segments of the population.
While exciting new technologies for mobile money transfer deservedly make the headlines, there's a drier aspect of financial inclusion that doesn’t get as much attention: regulation. Liliana Rojas-Suarez visits the CGD Podcast to explain how better regulation can improve both financial inclusion and financial stability.
Enabling millions more people around the world to control their financial futures is good for development and will be high on the agenda when G20 leaders meet in China later this year.
But while exciting new technologies for mobile money transfer deservedly make the headlines, there's a drier aspect of financial inclusion that doesn’t get as much attention: regulation. And it's no less important.
“There is no innovation that actually comes to life without the rules that determine how it’s going to operate,” CGD Senior Fellow Liliana Rojas-Suarez tells me in this week’s podcast.
Rojas-Suarez, along with Federal Reserve Board Senior Adviser Stijn Claessens, together chair CGD’s High Level Task Force on Regulatory Standards for Financial Inclusion. Their new report makes clear that the traditional priorities of financial regulation – safeguarding the stability and integrity of financial systems and protecting consumers from fraud – can be compatible with the goal of financial inclusion.
In fact, the two are complementary. “There is no way that you are going to get financial inclusion if you have an unstable financial system,” Rojas-Suarez says in the clip below.
"The more financial inclusion you have, that also contributes to stability, because you’re moving the funds that people are dealing with from the informal to the formal system.”
The rise of digital technology has nurtured a growing industry in financial services that benefit the poor, from mobile payments and money transfers to micro-savings and mobile-based crop insurance. But as the financial landscape evolves to include these disruptive innovations, new players and new business models could bring fresh risks to individual users and to financial systems. So how should policymakers respond?
The new government in Buenos Aires has taken quick steps that send a strong message to the world: Argentina wants to open its markets. President Mauricio Macri’s moves to ease market distortions caused by currency controls, trade taxes, and a lack of international financing, have greatly improved local and international expectations about the country's future. However, history shows that the road to a more market-friendly economy can be rocky. Moreover, the challenges can be monumental under small fiscal space, as the recent experience in Brazil demonstrates.
Conventional wisdom has it that when the United States catches a cold, Latin America gets pneumonia. But when the United States caught financial pneumonia in 2008, Latin America escaped with little more than a cold. What’s changed?
In this week’s Wonkcast, CGD senior fellow Liliana Rojas-Suarez explains why Latin America was mostly successful in coping with the fallout from the 2008 global financial crisis and she introduces a new methodology for predicting how countries will fare in the next global financial crisis. Our conversation draws on her new working paper, Credit at Times of Stress: Latin American Lessons from the Global Financial Crisis, written jointly with Carlos Montoro of the Bank for International Settlements (BIS).
The link between financial sector health and development can often seem abstract compared to issues such as trade, jobs, or childhood vaccinations. Regardless, finance is essential for development, explains Liliana.
“The truth of the matter is, there is not a single transaction that we undertake that does not involve finance,” she says. “Without finance, there is simply no development. Taking aside wars and major diseases, financial crises kill more people than anything else in the world.”
Liliana and Carlos Montoro undertook a study at BIS which examines how countries stood financially in 2007, to see if key indicators would predict how they fared in the 2008 crisis. The study weighed several macroeconomic indicators such as the amount of debt a country owes to the rest of the world and the amount of its national reserves. A third variable, the level of a country’s currency mismatch, has a large impact on a country’s ability to deal with a financial crisis, explains Liliana.
“For example, the if a Latin American government borrows U.S. dollars to build a road, and the government then collects taxes in the local currency” to repay the loan, says Liliana. “But, say the crisis hits and the local currency loses value. How is the government going to pay back the loan if the government doesn’t have enough U.S. dollars accumulated as foreign exchange reserves? So if you have a big currency mismatch, you’re going to be more vulnerable.” Most Latin American countries learned this lesson from previous crises and, as a result, have significantly reduced currency mismatches as well as accumulated large amounts of foreign currency reserves.
The indicators predicted that Asian countries would fare the best – and they did. China, Taiwan, Korea, and the Philippines came out on top. Latin America followed closely behind, and emerging Europe fared the worst. Liliana explains that countries such as Latvia and Estonia were in a bad position relative to their currency mismatch. These countries borrowed large amounts of Euros prior to the crisis, and then saw their currency depreciate after the crisis – causing them to suffer the most.
I ask Liliana to what extent culture comes into play in these results. For example, it seems to me that there’s a quality in Asian economic management that anticipates hardship and places strong emphasis on being prudent.
Liliana says there’s something to my theory, but you can only protect yourself against what you see coming. For example, currency mismatches played a large role during the East Asian crisis of 1997. Asian and Latin American countries learned from this period, but Eastern Europe did not.
At the end of the Wonkcast, I ask Liliana if her indicators could predict what will happen if the situation in Greece worsens and the world suffers another global financial shock. Liliana says yes, and predicts how countries will fare, based on her new index.
“We looked at where countries were at the end of 2011 and did the same experiment,” says Liliana. “Some Latin American countries such as Brazil are a little weaker now because they have used up some of their buffers, but Chile remains strong, and China remains strong.”
The weakened countries are working to build up their foreign reserves and pay down debts to restore fiscal strength but only time will tell if they’ve done enough, Liliana says.
I’d like to thank Alexandra Gordon for serving as producer and recording engineer, and for helping to draft this post.
The agenda for the G-20 finance ministers and central bank governors meeting in Sydney this weekend focuses on two themes: promoting stronger economic growth and employment and making the global economy more resilient. The G-20 leaders have recognized that expanding and strengthening capital markets in developing countries is crucial to both these goals and member countries have identified this as a priority issue for their deliberations.
Why? It’s widely understood that stronger and deeper capital markets can help to mobilize domestic savings and support the efficient allocation of resources, increasing investment and growth. Moreover, greater availability of domestic capital, at longer maturities and denominated in local currency, makes emerging economies less vulnerable to external financial shocks. But while there has been some progress, capital markets remain illiquid and underdeveloped in most emerging markets and developing economies.
There is plenty of research on the factors that facilitate the growth capital markets, including by the G-20 itself. But there are two crucial points that the G20 should not miss. First, the preconditions for capital market development, which I group into four pillars in a recent BIS paper, are interdependent: fragilities in any single pillar weakens the others; all pillars are equally important and necessary. Second, even if all the necessary conditions are in place, this may not be sufficient for developing countries to achieve the desired resilience against adverse external shocks; as these economies still lack the capacity to issue internationally recognized safe assets.
The Necessary Conditions for Capital Markets Development
The four pillars for capital markets development are: 1) macroeconomic stability, 2) sound banking systems, 3) solid institutional frameworks, and 4) adequate regulation and supervision. These examples show why all four pillars are interdependent:
Regulations for capital markets development (pillar 4) cannot be effective if they lack the support of a solid institutional framework that protects the rights of investors and creditors (pillar 3). South Asia, the Middle East and North Africa, and Latin America, which trail other parts of the world in measures to resolve insolvent firms also have the least developed capital markets.
In countries with economic instabilities (pillar 1), weak judicial systems (pillar 3) and/or fragile banking systems (pillar 2), even a well-designed bankruptcy law (pillar 4) will not allow for the orderly restructuring of firms in distress. Firms’ liquidation—even at fire sale prices— will be the creditors’ preferred choice, as they assign a very low probability to the recovery of their investments, perhaps due to lack of trust in the country’s macroeconomic management or institutional framework.
No capital market regulation, even if effective (pillar 4), can ensure the availability of liquidity (very much needed for the operations of capital markets) provided by sound banks (pillar 2).
Liberalizing the foreign-investment rules of private pension funds (pillar 4) in countries lacking macro stability (pillar 1) and financial stability (pillar 2) might exacerbate capital outflows in case of an adverse shock. In my view, Chile followed the right sequence: controls on investments in foreign securities were gradually lifted as the economic, regulatory and institutional environments gained strength.
A Longer-Term Constraint for Domestic Capital Markets’ Resilience
However, the four pillars while strictly necessary, are not sufficient. International experience has shown that even if all the pillars are in place countries that lack the ability to issue internationally recognized safe assets tend to have shallower and less-resilient local capital markets. Investors naturally prefer assets that maintain liquidity in bad times. There are just a handful of these safe assets in the world: government securities from countries that issue hard (e.g. highly liquid, internationally traded) currencies; US Treasuries top the list. During the global financial crisis, equity and bond instruments in emerging markets lost liquidity and prices collapsed.
Here’s where the G-20 comes in. Given the crucial importance of the ability to issue safe assets—and the limited number of such assets available—attaining fully functional, deep and stable local capital markets in developing countries will require more than just policy actions at the country level. Multilateral arrangements are needed to provide liquidity to these markets when needed. While some initiatives such as the IMF Flexible Credit Line can somehow help (although in an indirect way), they are insufficient. Much more needs to be done. The G-20 is uniquely positioned to begin the process, through instructions to the IMF and other multilateral institutions where the G-20 countries’ effectively call the shots.
Economic recovery in Latin America and the Caribbean (LAC) is gaining momentum, but more work is needed to ensure growth is both sustainable and inclusive. Looking ahead, activity is expected to gather further momentum—reflecting stronger demand at home and a supportive external environment. But there are still challenges ahead. Risks to the region’s outlook reflect internal factors as well as heightened external risks—notably, a shift towards more protectionist policies and a sudden tightening of global financial conditions. Additionally, longer-term growth prospects for Latin America and the Caribbean remain subdued.
This paper presents lessons derived from the 2008–09 financial crisis for Latin America and developing countries in other regions that might seek economic growth in the context of greater integration to the international capital markets.
At a dynamic event, CGD’s Latin America Initiative gathered experts to discuss the major economic constraints Latin America is facing in a less favorable international environment and what we can expect for the region’s economic growth and poverty reduction in the coming years. Speakers, including representatives from the World Bank, Inter-American Development Bank, Tulane University and CGD, began the event with a focus on macroeconomic issues and then shifted their attention to microeconomic issues (productivity) and poverty. The event served to define a clearer policy agenda for Latin American in the context of falling commodity prices, increased current account deficits, and negative productivity gaps.
I kicked-off the event by expressing concern about Latin America’s economic and financial vulnerabilities. Specifically, I’m concerned that, relative to other emerging markets, Latin America’s economic resilience to adverse external shocks has significantly declined since the global financial crisis. I showed this point through my new Indicator of Macroeconomic Resilience to External Shocks, which I recently laid out in an essay and in my recent blog post with Rajesh Michandani. Below is a quick illustration of the Resilience Indicator. For a sample of 21 countries, the graph compares the value of the indicator in 2007 (the pre-global financial crisis year) with the respective values at the end of 2014. A country’s performance goes from light (2007) to dark (2014) and all 21 countries lie along a color gradient: the red end of the spectrum indicates greater relative vulnerability, flowing through to light blue for relative resilience.
Macroeconomic Resilience Indicator
With the exception of Colombia, the indicator of relative macroeconomic resilience has deteriorated in all Latin America countries in the sample, albeit at very different degrees. This is mainly due to large current account deficits in the region caused by the drastic fall in commodity prices and deteriorated fiscal positions. Thus, some bad luck in unfavorable terms of trade, but also the squandering of opportunity to implement needed reforms in the good post-crisis years are the main reasons behind this outcome.
However, while experience has shown policy-makers that a high current account deficit, and therefore low domestic savings ratio, is inconsistent with sustained growth, standard theory doesn’t shed a clear light on why this is the case, particularly in middle income countries. In his presentation, Augusto de la Torre, chief economist for Latin America and the Caribbean at the World Bank, provided an alternative theoretical explanation on how increased savings leads to higher economic growth. Consequently, de la Torre said, a savings mobilization agenda should make sense for many Latin American countries. In his view, raising savings is doable in the region through a combination of fiscal, financial and safety net reforms. Moreover, at all times it is essential to have in place the right policy mix that addresses the long-term growth objective with the short-term macroeconomic goals. For example, in the current adverse international environment, “the best way to adjust would be tightening the fiscal and loosening the monetary… Tightening the fiscal [policy] will create a more robust saving environment that will help long term growth, and loosening the monetary [policy] will lower interest rates, and investment will pick-up,” he said.
Shifting the conversation to microeconomic issues, Santiago Levy, vice president for Sector and Knowledge at the Inter-American Development Bank, said that beyond short run macroeconomic issues and world commodity cycles, Latin America’s growth problem is mostly a productivity problem. “Productivity is a reflection of a country’s institutions, policies and programs” said Levy. “What makes the difference between Asia and Latin America is that [Asia’s] institutions have been more conducive to productivity and pragmatism, dealing with the redistribution issues in a better way, while Latin America hasn’t been able to do that.” To reignite growth in Latin America, Levy strongly suggested the formation of a productivity agenda that (i) channels resources to their most productive uses and (ii) increases the quantity and quality of human capital. While the first task would yield results in the short run, the second would be essential for long term productive transformation. Furthermore, such an agenda would avoid wasting resources (e.g., engineers becoming taxi drivers) and prevent the loss of resources (i.e., “brain drain”).
Finally, CGD non-resident fellow Nora Lustig suggested that declining inequality will be key for sustaining the reduction of poverty and the expansion of the middle class in the region, given growth in Latin American countries is expected to remain low. Lustig forecast that inequality will depend on three main determinants: labor earnings, government transfers, and private transfers (i.e., remittances). Among these determinants, she said, private transfers are likely to continue to be the main positive equalizing force for Latin America as the United States recovers from the financial crisis. Much of Lustig’s presentation echoed her work on the Commitment to Equity project, which analyzes the impact of a country’s fiscal policy package on poverty and inequality.
You can watch the entire event here. If you want to know more about what challenges Latin America is facing towards world trend dynamics, check out CGD’s Latin America Initiative.
Regulators at the Bank for International Settlements (BIS) in Basel, Switzerland, are hard at work designing regulatory standards to avoid future financial meltdowns like the global financial crisis of 2008. Joining them for two months is Liliana Rojas Suarez, a CGD senior fellow and the founding chair of the Latin American Shadow Financial Regulatory Committee.
I spoke with Liliana just before she left for Basel about macroprudential regulation—an approach that focuses on the systemic risks arising from the collective action of financial institutions. (Liliana had spoken about this at a recent CGD Research in Progress staff meeting; her slides are a useful adjunct to our Wonkcast discussion.)
Among the tools attracting greater attention with a macroprudential regulatory approach is the setting of capital requirements—the amount of funds that a financial services firm is required to hold as a buffer to offset unexpected losses in asset values, such as an unexpected and large increase in non-performing loans. While capital requirements are certainly not new, an important innovation of the macroprudential approach is the time-varying nature of the requirements, Liliana explains.
For example, under the new approach banks would be required to increase their holdings of high-quality capital during good times, then reduce them during economic downturns, so that lending could continue. During financial crises, “it is almost impossible to avoid a certain decline in lending, but what you don’t want to have is a credit crunch,” says Liliana. “Avoiding a crunch on credit is the key in-order to keep businesses afloat.”
The problem comes, Liliana explains, with definitions of what sort of capital counts towards "high-quality" capital. In developed countries, the list of financial instruments that have been allowed to count as capital is large (including preferred equity). The crisis demonstrated that most of these instruments didn't meet the necessary conditions to protect the solvency of the financial institutions when it was needed the most. In contrast, banks' capital in most developing countries is simple: non-distributed profits and cash contributions.
This straightforward capital is of the best quality and has served financial systems in developing countries well during the global turbulence of 2008-09. Liliana warns, however, that developing countries’ performance during the financial crisis is not a reason for complacency: many still face important deficiencies in accounting standards, consolidated supervision and risk-management techniques. The trick is to develop macroprudential regulations that are appropriate to these settings.
I also asked Liliana what leverage international standard setting-setting bodies advocating macroprudential reforms have to enforce their recommendations.
“At the end of the day, it ultimately depends on the political will of every country to implement the recommendations,” she says. This is a problem since the United States and other economic giants whose regulatory gaps can have global costs are those least likely to comply, she says. But international standard-setting bodies exercise considerable influence over multilateral institutions, like the IMF and World Bank, which in turn hold considerable leverage over developing countries. This concerns Liliana, who sees a problem with imposing macroprudential regulations that are tailored for developed countries on developing countries’ financial systems.
As we wrap up, I ask Liliana why Latin America recovered from the financial crisis so quickly while the United States and Europe continue to struggle to rebound. A combination of learning from repeated crises, extreme caution from regulators, and a less sophisticated financial system helped Latin countries soften the blow of the crisis, she said. Have something to add? Ideas for future interviews? Post a comment below, or send me an email. If you use iTunes, you can subscribe to get new episodes delivered straight to your computer every week. My thanks to Will McKitterick for his production assistance on the Wonkcast and for drafting this blog post.
Toward the end of the 2008 global economic crisis, the consensus was that developed economies would recover just as quickly as they did in past recessions. It was also expected that emerging market economies would continue acting as the world growth locomotive for a relatively long time. Until mid-2011, this perspective appeared to be in the process of materializing. By now, however, this scenario differs significantly from reality.
As a result, the consensus among international analysts has, therefore, become increasingly pessimistic. In the case of developed economies, the slow recovery has even led some experts to suggest the possibility of entering into a secular stagnation process. In Latin America, the economic slowdown has reverted growth rates towards potential rates similar to historical averages following a strong expansionary period. Between 2009 and 2013, the region benefited from the aggressive response to the 2008 crisis by advanced economies’ central banks (particularly the Fed) and the strong countercyclical policy in China. Nowadays, part of Latin America’s slowdown is clearly cyclical. After the boom in commodity prices, there was a strong increase in investments related to these industries, which is now coming to an end.
These developments are of special interest to the Latin American Shadow Financial Regulatory Committee (CLAAF for its Spanish name), a group of leading experts on Latin American economics that I (Liliana) chair. In the latest CLAAF statement, the committee identified two additional risk factors that have not been appropriately internalized by the current consensus. The first is that asset liquidity might fall significantly when the Fed increases interest rates, a move the market has started to anticipate. This fall in asset liquidity might drastically reduce emerging markets’ external funding. The second is that there are indications that a slowdown in China’s economic growth will be deeper than what is forecasted by the current international consensus. The committee also identified an additional risk factor resulting from a larger fall in commodity prices than anticipated by consensus estimates.
Committee members find that Latin America is less able now to face to risks than it was in 2008. There are a number of reasons:
Excessive public and private expenditure and insufficient savings ratios led to a deterioration of current account balances even before the recent decline in commodities prices.
Public-sector deficits increased significantly in several countries, including those where countercyclical fiscal policies adopted in 2009 were not reverted during the subsequent recovery.
Domestic costs of production increased faster than productivity, reducing competitiveness in non-commodity tradable industries.
Indebtedness levels of firms and families are relatively high in several countries.
Efforts for increasing productivity in the region have clearly been insufficient.
The risks from the global scenario described above have a clearly systemic dimension. In this context, CLAAF believes that it is desirable to strengthen the international financial architecture to improve its capability to respond to a sudden deterioration in global financial markets. In particular, the committee recommends the following:
The creation of an Emerging Markets Fund (EMF) with the capacity to intervene in sovereign debt markets for the purpose of reducing volatility. Such a fund may intervene in debt markets in case of systemic financial turmoil and under predetermined rules.
To complement the role of current multilateral organizations, particularly the IMF, through the creation of regional institutions. In this regard, the Committee favors the creation of a Latin American Liquidity Fund mainly aiming at (1) providing liquidity to the public sector and (2) providing credit that can mitigate the possible volatility in trade credit lines. The committee estimated that such institutions should need a capitalization of US$ 50 billion and a lending capacity of US$ 100 billion, equivalent to the net liquidity needs by the region during the 2008–09 crisis (this recommendation has been previously stated by the committee in its Statement No. 27).
That countries in the region run new stress tests in order to update possible financial needs for the public and private sectors that might arise if the Fed increases interest rates suddenly.
To keep appropriate exchange rate flexibility and avoiding “fear to float” behaviors. The countries that are most able to reduce currency mismatches in balance sheets and dollarization will be better positioned to face the challenges of a greater financial volatility and lower economic growth.
This and previous CLAAF statements are available in English and Spanish. You can also click here to watch an interview (in Spanish) with Liliana about the latest CLAAF meeting in Lima, Peru.
Hacia fines de la crisis de 2008, era común suponer que las economías avanzadas habrían de recuperarse de manera similar a como lo había hecho tras otras épocas recesivas en el pasado, mientras que se esperaba que las economías emergentes actuarían como la locomotora del crecimiento mundial por un periodo relativamente largo de tiempo. Hasta mediados de 2011, esta perspectiva parecía que iba a concretarse. Sin embargo, lo efectivamente observado difiere en grado relativamente importante respecto de ese escenario.
Actualmente, el sentimiento generalizado entre los observadores de la economía internacional es crecientemente pesimista. En el caso de las economías avanzadas, la lentitud del proceso de recuperación ha incluso llevado a algunos a sugerir la posibilidad de que estarían entrando en un proceso de estancamiento secular. En América Latina, una consecuencia de la desaceleración económica es que las tasas de crecimiento de la región están revirtiendo hacia tasas potenciales similares a su promedio histórico tras un período de fuerte expansión. En el período 2009-2013, la región se vio beneficiada por la respuesta extremadamente expansiva de los bancos centrales del mundo avanzado, en particular la FED, a la crisis del 2008, y por la fuerte política anticíclica implementada en China. Ahora, en contraste, parte de la desaceleración de la región es claramente cíclica ya que, tras el boom en el precio de las materias primas, existió un fuerte aumento en la inversión asociada a estos sectores que ahora está concluyendo.
Esta sucesión de eventos es de especial interés para el Comité Latinoamericano de Asuntos Financieros (CLAAF), un grupo de los economistas más influyentes de América Latina, el cual presido actualmente. En la última declaración de CLAAF, el comité identifica dos factores adicionales de riesgo global que no han sido internalizados adecuadamente por el consenso actual. El primero es que la liquidez de los activos de los emergentes podría ser altamente susceptible a una fuerte caída cuando suban las tasas de interés de la FED. Esta disminución de la liquidez podría verse reflejada en una reducción drástica en las fuentes de financiamiento externo de los países emergentes. El segundo es que existen razones de peso por las cuales China podría estar enfrentando una desaceleración mucho más significativa en su crecimiento de la que surge del consenso actual. El comité también identifica un factor adicional de riesgo regional, que es la posibilidad de que los precios de las materias primas se reduzcan de manera más rápida de lo que el consenso actual internaliza.
Estos riesgos adicionales que el comité ha identificado encuentran a América Latina en condiciones iniciales más frágiles que las que existían en el 2008, debido a las siguientes razones:
El exceso de gasto público y/o privado y un nivel insuficiente de ahorro llevó a un deterioro de los saldos de cuenta corriente, aún antes de que disminuyeran los precios de las materias primas.
El déficit fiscal ha aumentado en varios países, incluyendo aquellos en los que las políticas anticíclicas adoptadas en el 2009 no se revertieron.
Los costos domésticos de producción crecieron más rápidamente que la productividad, reduciendo la competitividad de los sectores transables no productores de materias primas.
Los niveles de endeudamiento de las empresas y familias son relativamente altos en varios países.
Los esfuerzos por aumentar la productividad en la región han sido claramente insuficientes.
Los riesgos del escenario global descrito anteriormente tienen una dimensión claramente sistémica. En ese contexto, la visión de CLAAF es que es deseable avanzar decididamente hacia un mayor fortalecimiento de la arquitectura financiera internacional en cuanto a su capacidad de responder a un deterioro repentino en el contexto financiero global. En particular, el comité recomienda:
La creación de un Fondo para Mercados Emergentes (FME) con capacidad de intervenir en los mercados de deuda soberana con el fin de contribuir a reducir la volatilidad de los precios de dichos activos. Dicho Fondo podría intervenir en los mercados de deuda en situaciones de turbulencia financiera sistémica y bajo reglas predeterminadas.
Complementar el rol de las instituciones multilaterales actuales, en particular el FMI, mediante la creación de un Fondo Latino Americano de Liquidez con dos funciones principales (1) la provisión de liquidez al sector público y (2) la provisión de préstamos para mitigar la posible volatilidad en las líneas de comercio exterior. El comité estimó que dicha institución debía contar con un objetivo de capital de USD 50 billones y una capacidad prestable de USD 100 billones, equivalente a la necesidad neta de liquidez de la región durante la crisis de 2008-2009 (esta recomendación también se encuentra en la declaración de CLAAF No. 27).
A los países de la región, realizar nuevos stress tests que permitan actualizar las posibles necesidades de financiamiento de los sectores público y privado asociadas con un repentino incremento en las tasas de interés internacionales en un contexto de desaceleración económica y caída de precios internacionales de materias primas.
Mantener una adecuada flexibilidad cambiaria y evitar comportamientos del tipo “miedo a flotar”. Los países que logren reducir al máximo los descalces cambiarios en las hojas de balance y la dolarización estarán en mejores condiciones para enfrentar los desafíos de una mayor volatilidad financiera y un menor crecimiento económico.
Ésta y todas las declaraciones anteriores del CLAAF están disponibles en español e inglés. También puede hacer clic aquí para ver la entrevista a Liliana acerca de la última reunión de CLAAF en Lima-Perú.