Volume 44, Number 172,
January-March 2013
The Role of Public Banking during
Financial Crises in Argentina and Uruguay
Wesley Marshall

Convertibility ( ...continuation )

The establishment of a monetary council, never before adopted in such a large and diversified economy in the post-colonial era, was always recognized as an experiment, even by the International Monetary Fund (imf), which was a main designer of the initiative (imf, 1994:9). As analysts from the Center for Studies of the Situation and Perspectives of Argentina (cespa) emphasize, convertibility was born with two congenital defects that it could never overcome: the overvaluation of the peso and high external vulnerability. It was conceived of as a temporary measure, although it lasted more than a decade. The last years of its existence were characterized by the growth of its congenital defects. At the end of the 1990s, the chronic overvaluation of thepeso, together with the sale of the largest national companies to trans-national firms that repatriated growing amounts of capital, had decimated the national productive plant. The abdication of monetary policy implied by the monetary council meant that the country’s finances depended on the willingness of external creditors. However, the partial privatization of the pension system in 1994, together with the financial crisis that resulted from the "tequila effect" in 1995, opened up a fiscal gap that would soon throw public finances into a debt trap, where greater debts increased interest rates, and as a result, the debt rose even more, creating a situation in which public finances were ever weaker, culminating in the financial crisis of 2001-2002 (Damill, Salvatore and Simpson, 2003a).

Although this undoing was the logical result of the design failures of convertibility, the evolution of the banking system —another determining factor of the 2001-2002 crisis— was less predictable. Between 1994 and 2003, there were two dramatic reorganizations of the banking system. First, there was the foreignization of the Argentinean banking system that occurred between the banking crisis of 1995 and the crisis in 2001-2002. Besides the debt that Argentina assumed with the imf, the 1995 crisis left a large number of Argentinean banks insolvent, particularly public provincial banks. Starting from that time, foreign banking entered the country with full force. Measured in assets, between December of 1994 and December of 2001, foreign banking increased its participation in the market from 18% to 61% (Moguillansky, Studart and Vergara, 2004: 23).

This change in ownership had the strong approval of local authorities, as it promised to ameliorate another key weakness of the monetary council: the lack of a lender of last resort for the national financial system. With the objective of eliminating the possibility of contracting a quasi-fiscal debt, strict limits on loans for the financial system were established for the Central Bank (bcra). Moreover, convertibility dictated that the monetary base had to be backed 100% by foreign currency, although up to 33% of the reserves could be national government bonds (Damill, Salvatore and Simpson, 2003a: 11). Without the capacity to rescue the financial system in case of a severe crisis,1 the authorities had to depend on foreign banks and banking oversight and regulation.

The key advantage that foreign banks have over their national counterparts is that the availability of credit lines does not depend on local financial conditions. For example, if there is a crisis in Argentina, all companies of that country face a certain degree of credit rationing in international markets. However, a Spanish bank with operations in Argentina does not face the same problem. In this way, while national banks would be forced to close credit lines in times of crisis, there would be no structural reason for a foreign bank to apply the same measures. As such, under the conditions of convertibility, foreign banks would have been able to operate as a lender of last resort, filling the gap left by the bcra. In Argentina, this possibility was not relegated to academic discussion. Foreign banks that operated in the country made explicit promises, through publicity campaigns, that in case of financial difficulties in Argentina, they would provide unconditional backing from their headquarters (Marshall, 2008).

The other tool that was used to compensate for the lack of a lender of last resort —banking regulation and oversight— proved to be fairly successful. During the decade of convertibility, the banking system never created a speculative or loan bubble. In 1998, the Argentinean banking system was ranked by the World Bank as the twenty-first strongest in the world, tied with Hong Kong (Yeyati, de la Torre and Schmuckler, 2002).

1 Although the 1995 crisis did change Argentina’s external debt profile and modified the composition of the financial market, it was relatively benign and short-lived, especially in comparison with the 2001-2002 crisis.

Published in Mexico, 2012-2017 © D.R. Universidad Nacional Autónoma de México (UNAM).
PROBLEMAS DEL DESARROLLO. REVISTA LATINOAMERICANA DE ECONOMÍA, Volume 48, Number 191, October-December 2017 is a quarterly publication by the Universidad Nacional Autónoma de México, Ciudad Universitaria, Coyoacán, CP 04510, México, D.F. by Instituto de Investigaciones Económicas, Circuito Mario de la Cueva, Ciudad Universitaria, Coyoacán,
CP 04510, México, D.F. Tel (52 55) 56 23 01 05 and (52 55) 56 24 23 39, fax (52 55) 56 23 00 97, www.probdes.iiec.unam.mx, revprode@unam.mx. Journal Editor: Alicia Girón González. Reservation of rights to exclusive use of the title: 04-2012-070613560300-203, ISSN: pending. Person responsible for the latest update of this issue: Minerva García, Circuito Maestro Mario de la Cueva s/n, Ciudad Universitaria, Coyoacán, CP 04510, México D.F., latest update: Nov 13th, 2017.
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