Latin American Capital Markets

96 VALERIANO F. GARCIA AND LUIS ALBERTO GIORGIOcial system, the demand for dollars increased significantly, and a full-fledged currencycrisis was triggered.The time-inconsistent macroeconomic policy, the insolvency of thebanking industry caused by public sector default and the private sector's lack of abilityto repay loans, and weak political leadership led to a run on the banks and the collapseof the banking system.During the "convertibility decade," Argentina strengthened its financial systemby (i) requiring banks to hold capital ratios much higher than those demanded by theBasle accord; (ii) imposing high loan-loss provisions and strict international accountingstandards; (iii) actively favoring the entrance of large foreign banks; (iv) requiring thatbanks issue subordinated debt in the form of bonds; (v) demanding that banks berated by international rating agencies; and (vi) imposing reserve requirements higherthan 20 percent on liquid deposits not withstanding their initial time structure. Thelack of a lender of last resort was addressed by buying the option to borrow liquidityfrom international banks through contingent credit lines that would be triggered inthe case of a currency run.Argentina's trade policies were not efficiently designed—they promoted onlypartial openness and integration with the rest of the world—but on all aspects relatedto its financial system, the country "went by the book" However one year later;the banking system was on the brink of complete insolvency, and the capital marketwas reduced to minimum activity. The meltdown was instantaneous because of thesize of the economic shock resulting from the accumulation of disequilibria related totime-inconsistent macroeconomic policies.The lesson from this episode is that microeconomic reform in the capitalmarket sector is a necessary but not sufficient condition. If macroeconomic policiesgenerate large disequilibria that may lead to a real and financial systemic implosion,even a strong financial system may collapse.In Argentina, the financial and economic crisis mainly affected access to financingfor small and medium enterprises (SMEs). However; SMEs had been sufferingthe brunt of the problems long before the financial meltdown.They had been payinga high risk premium imbedded in their interest rates. It is always the case that, in thistype of economic and banking crisis, SMEs suffer more than large corporations becauseSMEs lack financial resources. Large firms have the capability of hedging theirexposure to exchange rate depreciation, bypassing exchange rate controls, and obtainingcommercial credit when banking credit dries up.Several factors affected the competitiveness of all firms, including the appreciationof the real exchange rate, the lack of structural reforms in the labor sector, theheavy burden imposed by the taxing scheme, and the poorly designed privatizationCopyright © by the Inter-American Development Bank. All rights reserved.For more information visit our website: www.iadb.org/pub