Preventing banking sector distress and crises in Latin America

Abstract

This conference discussed topics relevant to preventing banking crises in Latin America and the Caribbean. Its main objective was to discuss origins and remedies, ultimately devising a common framework that would render banking systems less vulnerable to systemic shocks. Three pertinent areas are discussed: reserve requirements and narrow banking, deposit insurance, and market-based regulation. Presentations on narrow banking 1) advised against it to avoid transferring business to much less transparent institutions, like the equity market, the debenture market, and other credit-creating institutions; 2) advocated narrow banking as the best approach where payment systems would be shielded from risky assets transferred to other markets; 3) recommended increasing banks required capitalization and owners liabilities and demanding better financial information and disclosure; and 4) argued that the joint provision of deposit and credit services by banks is efficient, and that separating the services among specialized institutions would be welfare-reducing. Papers on deposit insurance 1) stressed its potential for increasing the probability of insolvency through moral hazard, encouraging excessive risk taking by bank managers and reduced monitoring by bank depositors; 2) concluded that with appropriate safeguards, government deposit insurance can be the best solution to dealing with the inherent instability of fractional reserve banking; 3) noted that deposit insurance is unnecessary when a government employs macroeconomic fundamentals; and 4) proposed a model to eliminate deposit insurance, with narrow banking as an option. The New Zealand model of market-imposed supervision and regulation of the financial sector was examined; and the conference concluded with a roundtable discussion on systemic banking crises, highlighting on a case-by-case basis the weaknesses of the different banking systems, and stressing the need to reduce banking fraud, improve supervision, and solve the problem of state banks.