Banking Soundness and Monetary Policy


Charles Enoch, and J. Green
Published Date:
September 1997
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Because of Miguel Mancera’s brief time, my remarks will focus on specific points in his paper. Mancera notes that even before December 1994 the financial system was in difficulty because of poor management during the post-privatization period, problems in dealing with the large capital inflows that occurred in the period from late 1988 to early 1994, and weak supervision. Then came the terrible political events of 1994 and the exchange crisis of December 1994 that resulted in a major deterioration in the situation of the financial sector. The authorities moved quickly to address the financial crisis and with the substantial improvement in the broad macroeconomic situation there are signs that the problems of the system are being overcome. In many respects the approach adopted by the authorities conforms to what are now considered best practices for dealing with bank unsoundness:

  • the fiscal costs were quantified and the budget was adjusted to make room for the public spending associated with the restructuring;
  • a separate agency (the VVA) was created to dispose of assets acquired by the government under the restructuring process, and some assets were removed from the balance sheet of banks to allow them to focus on their core activities; and
  • accounting standards, capital requirements, loan loss provisions, and bank supervision have been strengthened, while stricter limits have been imposed on lending to related interests.

However, Mancera’s paper is less clear with respect to other aspects of best practices—ensuring an equitable sharing among the government, the shareholders of banks, and depositors and other creditors, as well as changing the management and management practices of banks in trouble.

The government has borne substantial costs through the special incentives that have been created to encourage the injection of new capital into the banks (the temporary capitalization and portfolio purchase programs); the partial writing down of payments on various loans (including mortgages and agricultural loans); and the assumption of various risks (including interest rate risk under the UDI scheme and credit risk under the portfolio purchase scheme). Mancera has noted that the costs to the public sector of the bank restructuring operations are subject to uncertainty, and he may wish to comment on the principal risks that in the end the fiscal costs of the restructuring operations possibly could be higher than estimated in his paper.

Meanwhile, it seems that depositors and other bank creditors have been fully protected. It is not clear to what extent bank shareholders have contributed to meeting the cost of the crisis through a write down in the capital of banks. It is also uncertain as to whether any banks have been closed under the restructurings or if there have been any management changes in banks in trouble. Also, it is not clear to what extent the government development banks have been affected by problems in the financial sector, and what changes the government is making in the operations of these banks.

Based on these remarks, Mancera may want to elaborate in more detail on these aspects of the restructuring effort.

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