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Against Conventional Wisdom: LAC's Financial Sector Has an Opportunity to Expand without Creating Bubbles

November 29, 2011

New World Bank Report Assesses Progress and Setbacks,

Advocates Financial Inclusion


NEW YORK, November 29, 2011 – This isn’t exactly the perfect moment for banks to take on new risks. In such a volatile economic climate as today’s, the prudent thing seemingly would be to do very little. But, according to a new World Bank report, in Latin America and the Caribbean (LAC) the time is right for the financial sector to expand sustainably in new directions, to boost economic activity and financial inclusion.


LAC has demonstrated a strong financial footing, having weathered the global crisis of 2008-2009 better than most, according to the new World Bank flagship report, Financial Development in LAC: The Road Ahead, launched today at Columbia University in New York.


After a history of recurring instability, the region’s strengthening of its macroeconomic policies and oversight helped prevent toxic loans and U.S.-style bubbles.


"During the 1980s and 90s, financial sectors were the region's Achilles heel. Ever since, they have grown and deepened, becoming more integrated and competitive, with new actors, markets and instruments springing up," according to Pamela Cox, World Bank Vice President for Latin America and the Caribbean.Now that the successes of LAC's macro-financial stability are widely recognized and tested, it is the right time to move forward with a broader agenda”.


But greater financial stability and resilience hasn't translated into increased financial services, as compared to the world. According to the new report, banks in the region have several weaknesses:

  • They lend substantially less and charge more,
  • They disproportionately finance individuals’ consumption over firms’ production,  and
  • They are particularly stingy when it comes to mortgages.

In fact, consumer credit has expanded in LAC during recent years more than in comparable regions and, in relative terms, at the expense of firm financing and housing finance. Mortgage credit is by far the smallest compared with other regions of the world, standing at 14 percent of total credit in 2008-2009, as opposed to China's 58 percent, Eastern Europe's 49 percent, and the G7's 47 percent. Annual fees for checking accounts are double those of Asia's and seven times higher than Eastern Europe's.


"The development of the region's financial systems has been significant but far from homogenous. I have in the past emphasized the need for vigilance regarding Brazil’s fast growth in consumer credit. However, the fact remains that credit levels in the region, especially loans for firms and also mortgages, remain low," said Arminio Fraga, former Brazilian central banker, who participated in the presentation of the report. Fraga, who was head of Banco Central do Brasil from 1999 to 2002, is widely credited with helping turn Brazil's financial instability around.


The report finds that the underdevelopment of LAC's financial systems cuts across many indicators. While Chile has the most developed pension fund system, reaching 70 percent of gross domestic product, and Brazil has the largest mutual fund industry, reaching 42 percent of GDP, both of those indicators stand at or below 10 percent of GDP for the rest of Latin American countries.


Overcoming the region’s gaps in financial development requires better financial inclusion. Extreme caution should be taken, however, to avoid the type of excesses that the overexpansion of subprime mortgages entailed in the U.S. In this respect, the largest seven Latin American countries (Argentina, Brazil, Chile, Colombia, Mexico, Peru, and Uruguay) have adopted comprehensive policy agendas to promote financial inclusion, with notable successes in incorporating poor households and micro-enterprises. The rest of the region, however, has been less proactive in the financial inclusion agenda.


The challenge now –according to the report--is that Latin American financial services will have to improve within a more volatile international environment. The global crisis brought to the surface a series of excesses and vulnerabilities, which put into question the market’s ability to self-regulate and put a premium on good public policies that complement the actions of financial markets. So far, however, discussions on the need to go beyond traditional crisis-prevention tools and develop system-wide (“macro-prudential”) oversight, have yielded scarce results.


What can be done?


"Ensuring good systemic oversight in the region will be crucial to avoid costly crises in the future, especially considering that the drivers of vulnerability in the future may be more financial than macroeconomic,” said Augusto de la Torre, World Bank Chief Economist for LAC. "The recent crisis highlighted the need for the state to keep the process of financial development on a safe track, and to do so without undermining market discipline." De la Torre is coauthor of the report, together with Alain Ize, and Sergio L. Schmukler.


Other challenges faced by the region as it works to narrow financial development gaps include:

  • Finding the proper balance between regulating financial investments, on the one hand, and letting investors assume the risk, on the other.
  • Enhancing borrowers’ rights and their enforcement so as to promote credit creation.
  • Promoting the development of markets for long-term finance, necessary to increase productivity, without raising systemic risks.

All in all, LAC now has a much better foundation on which to build. Yet, in view of the turbulent global environment, there is little time to spare in preparing ahead for the new challenges of systemic oversight.

Media Contacts
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