Latin American Capital Markets

314 CLEMENTE DELVALLEAnother important fact in the case of Latin America is that, after achievinga higher level of development of their markets, countries introduce primary dealers.Argentina and Colombia introduced primary dealers in 1997, followed by Mexico in2000. Several countries based their dealers' scheme on the experience of Spain in thelate 1980s.That country successfully used primary dealers to promote its governmentsecurities, increase competition among participants, and lead the banking sector tothe disintermediation process.Investor Base for Government SecuritiesA diversified investor base is essential to create and develop a government securitiesmarket In the early stages of development, both developed and developing countrieshave historically relied on coercion and regulation to raise funds, for example, by establishingthat banks must meet their reserve requirements by holding governmentsecurities. The consequence of these practices is that market participants cannotreach an optimal portfolio, producing an opportunity cost for their investors' assetsand inducing some moral hazard within the government While most developedcountries have implemented reforms toward eliminating such distortions, few developingcountries have introduced reforms to change the situation.The commitment tomarket-oriented funding strategies is especially threatened when government facesdeteriorated fiscal conditions that could prompt the return to the use of captivesources of funding.Commercial banks are one of the major investors in government securities,particularly at the early stages of market development They allocate resources in governmentbonds not only to meet reserve and liquidity requirements but also to manageshort-term liquidity, provide collateral for repo transactions, obtain stable interestincome, and hedge interest rate positions. However, a more permanent, strong presencein the government securities market could indicate that those banks are weak indoing their job, which is lending. 3 When banks are the dominant player in the marketand limited competition exists, some resistance could arise against developing a governmentbond market because it would lead to a disintermediation process thatwould threaten the banks' traditional business. Government action becomes essentialin those markets where banks are the owners of related financial business, such as in-3 This behavior can also be seen in countries that have recently gone through a financial crisis and/or an economic recession.Thesesituations could induce a credit crunch due to the high credit risk perceived by banks and the high costof maintaining prudential reserves.Copyright © by the Inter-American Development Bank. All rights reserved.For more information visit our website: www.iadb.org/pub