Latin American Financial Contagion: A Lingering Threat?

Abstract

This paper examines the recent status of financial liberation and integration of Latin American banking and the ongoing interdependence of banking systems in Latin America with those in the Eurobanking systems. Correlation and regression analysis of unlagged price index data is firstly undertaken. The analysis then moves to cointegration, impulse response and variance decomposition analysis of lagged first differenced data to examine the short and long-term relationships. There is evidence of interdependence and cointegration between the Latin American banking systems and between the major Eurobanking systems interacting with the major Latin American systems (proxied by banking stock price indices). In the short-term Latin America exogeneity lies primarily with the Brazilian system followed by those with Mexico, Argentina and Chile with minimal contributions by the systems in Peru and Colombia. The evidence of the relationships between the Latin American banking systems and the Eurobanking systems shows that exogeneity lies primarily with the Eurobanking systems of the USA, Canada, the European Monetary Union, the United Kingdom and Japan and the strength of the exogeneity is in the above order. Diversification of cross bank shareholdings, and interbank lines of credit in Eurobanking systems along with continued vigilance in banking regulation primarily in Latin American banking systems is needed to keep the lingering threat of financial contagion at bay.