II Role of Banks in Developing Countries
  • 1 0000000404811396https://isni.org/isni/0000000404811396International Monetary Fund
  • | 2 0000000404811396https://isni.org/isni/0000000404811396International Monetary Fund

Abstract

Financial systems in developing countries are typically dominated by banks: bank deposits constitute the most important form of household savings, and bank loans are the most important source of external finance for firms. As will be shown below, Latin American countries by and large have this type of financial structure. This section focuses on the particular features that distinguish banking systems in developing countries from those in industrial countries and on the special role that the banking sector plays as a source of economic growth in developing economies.

Financial systems in developing countries are typically dominated by banks: bank deposits constitute the most important form of household savings, and bank loans are the most important source of external finance for firms. As will be shown below, Latin American countries by and large have this type of financial structure. This section focuses on the particular features that distinguish banking systems in developing countries from those in industrial countries and on the special role that the banking sector plays as a source of economic growth in developing economies.

Banks—in both industrial and developing economies—can be distinguished from other financial institutions by a unique characteristic that will be termed here “the franchise value of banks,” that is, the special power conferred by the banking charter to issue liabilities that are accepted as a means of payment. In developing countries, the state of the legal and accounting systems makes it difficult for institutions that are not connected to the payments system to issue short-term liabilities such as commercial paper. Hence, banks are the only nongovernment issuers of these liabilities. Because investors require borrowers’ liquidity as proof of their solvency, borrowers are restricted to the short-term market, which is dominated by banks.1

Overview of Financial Structure in Latin America

Commercial banks played a central role in Latin America in the 1980s. As reported in Morris and others (1990), these institutions provided short-term financing that, owing to the severe economic difficulties these countries faced during the decade, was the only kind of resource that financial institutions could mobilize.

During the late 1980s and early 1990s, a number of variables, both domestic (macroeconomic stabilization programs, financial liberalization, and financial sector reforms) and external (the decline in interest rates in the United States and other industrial countries, which increased foreign investors’ demand for Latin American securities), contributed to the rapid expansion of alternative sources of finance for firms, such as bonds and equity. However, bank loans remained the most important source of finance for the private sector.

The composition of credit commercial banks and other financial institutions (excluding the stock exchanges) provided to the private sector in a number of Latin American countries indicates a clear bank dominance through the 1980s and early 1990s although the importance of banks varied across countries and across time (Table 1). In this regard, two clarifications of the data are needed.

Table 1.

Composition of the Stock of Net Credit to the Private Sector by Commercial Banks and Other Financial Institutions

(Percent)

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Source: IMF staff estimates.Note: Commercial banks include private and government-owned commercial banks. Other financial institutions include development banks and all other financial institutions whose activities are reported by the central banks. The informal financial markets and the stock exchanges are not included.

Commercial banks include national and provincial banks also.

June 1992 data.

After 1985, commercial banks include the Bank of Brazil. The rest of the banking system includes the National Development Bank (BNDES), state development banks, investment banks, the Federal Savings Bank (CEF), state savings banks, savings and loan associations, housing credit companies, the National Housing Bank (BNH), and the National Bank of Cooperative Credit (BNCC).

1988 data.

Including nonbank financial intermediaries and pension funds.

A new reporting system for financial system accounts was introduced at end–1990. Data for 1990 are therefore not strictly comparable with earlier data. Data for 1990 exlude PROEXPO.

Comprising development finance corporations, trade finance companies, savings and loan companies, cooperative institutions, and development banks (BANCOLDEX, FINAGRO, FINDETER).

Including development banks.

August 1992 data.

Includes National Bank for Agricultural Development (BANADESA), the Municipal Bank (BMA), the specialized savings institutions, the National Investment Corporation (CONADI), and private nonbank financial intermediaries. The private nonbank financial intermediaries consist of the Honduran Federation of Savings and Loan Cooperative (FACACH), insurance companies, and the Honduran Federation of Housing Cooperatives (FEHCOVIL).

Includes the National Bank and development banks only.

Includes mortgage banks, the Agricultural Development Bank (BANDAGRO), savings and loans, and the Workers’ Bank.

First, owing to a lack of consistent data across Latin American countries, development banks—institutions, typically government owned, established to extend credit to specific sectors of the economy—are included under “other financial institutions.”2 Hence, in several countries, a large component of credit extended through other financial institutions is also bank credit.3 For example, assets held by development banks in Bolivia, Guatemala, and Peru accounted for 21, 14, and 47 percent of total assets of financial institutions, respectively, by the end of 1987 (Morris and others, 1990). The importance of development banks, however, declined significantly during the late 1980s and early 1990s, reflecting the privatization programs in many Latin American countries. Mexico is a clear example of the privatization efforts; there, the share of commercial bank credit in total credit to the private sector increased from 76 percent in 1987 to 91 percent in 1992. The same trend is apparent in Bolivia, Brazil, Ecuador, and Peru.4 The reduction in government participation in the financial sector has, therefore, resulted in a significant increase in the importance of commercial banks in financing the activities of the private sector. Indeed, the share of credit from commercial banks in total credit to the private sector clearly exhibited an upward trend during 1980–92 in all but one of the countries shown in Table 1. The exception was Colombia, where savings and loan institutions maintained about one-third of the total financial credit to the private sector throughout the period under consideration.

Second, the data in Table 1 do not include the informal financial market and the stock exchanges. The informal market became an important source of financial intermediation in many Latin American countries during the years of severe financial difficulties in the banking sectors of several Latin American countries; that pattern, however, reversed in the late 1980s and early 1990s in many countries as stabilization policies and policies directed at restructuring and recapitalizing banks resulted in a reintermediation of financial activities back into the formal institutions (see Section III). In contrast, the stock exchanges were not important sources of finance for the private sector as a whole during the early and mid–1980s when many Latin American stock markets even contracted, as reflected by their market capitalization measured both in U.S. dollars and as a percentage of GDP (Table 2).5

Table 2.

Market Capitalization

(Percent of GDP)

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Sources: International Finance Corporation, Emerging Stock Markets: Factbook, various issues; and International Monetary Fund, World Economic Outlook.

Consistent with better economic prospects and, more recently, with a large inflow of foreign capital, market capitalization in several of these countries recovered in 1989–90 and expanded dramatically in 1991–93.6 In spite of the tremendous growth of equity prices and in the daily turnover of private sector shares, equity finance in Latin America is still confined largely to the largest corporations and has not yet become a significant competitor for bank finance for the corporate sector as a whole.

The number of companies listed on several Latin American stock exchanges is shown in Table 3. Although the absolute number of listed companies has limited usefulness because it does not account for the difference in size among corporations or the size of the country, the important conclusion that can be derived from Table 3 is that, with the exception of Peru, the number of listed companies did not show any significant growth in spite of the sharp increase in market capitalization during the most recent period. These data, therefore, indicate that the large capitalization observed recently in several countries may be attributed to the performance of a limited number of stocks and not to a generalized improvement in the performance of corporations in Latin America. Moreover, by the end of 1993, market concentration—measured as the share of market capitalization held by the ten largest stocks—was above 50 percent in a number of Latin American countries, including Argentina, Chile, Colombia, Peru, and Venezuela. This compares with a much lower market concentration in several developing countries in Asia (including China, Indonesia, Korea, Malaysia, and Thailand), which averaged about 30 percent by the end of 1993.7

Table 3.

Number of Domestic Companies Listed on Selected Stock Exchanges

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Source: International Finance Corporation (1993).

Have banks remained the single most important source of finance for the private sector? The paper explores the possibility of using national flow of funds data, which provide information on financial asset and liability structures across sectors. Data on corporate financial structure are essential to assess the relative importance of bank loans in financing production. Unfortunately, flow of funds data are practically nonexistent in most Latin American countries. Indeed, time-series data on flow of funds were found only for Chile (for 1978–91).8 However, given the recent developments in financial markets in Chile—the rapid growth of pension funds, the significant increase in the issuance of corporate bonds, and the rapid increase in market capitalization in the stock exchange—it is worth exploring what this experience may show in terms of the importance of bank loans in financing private sector activities.

Table 4 shows the financing sources available (in stocks) for households and firms in Chile during 1978–91. It is well known that increases in equity prices may present a problem in measuring the relative sources of corporate funding because part of the increase in equity prices may be due to capital gains on projects undertaken and financed in previous years. For example, assume a firm undertakes a million peso project in year 1 that it finances half with equity and half with bank loans. In year 2, the market value of the project increases to 2 million pesos in real terms. The equity issued in year 1 will reflect the entire capital gain on the project, not just that earned on the equity portion because the bank loan does not capture capital gains. Thus, in year 1, using current market prices of equity, bank financing and equity financing are each 500,000 pesos. In year 2, equity financing increases to 1.5 million pesos and bank loan funding remains constant, even though the proportion of the project funded by each instrument has not changed. Corbo and others (1992) attempt to correct for this effect, and it is their adjusted figures that are used here.9

Table 4.

Chile: Private Sector Finance Structure

(Ratios of total domestic financial liabilities outstanding)

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Source: Corbo and others, El Sistema Bancario Chileno: Desarrollos Recientes y sus Perspectivas, Instituto de Economía, Pontificia Universidad Católica de Chile (1992),Table 3.Note: The finance structure includes domestic sources of finance and government enterprises. Ratios do not need to add to one because there are other financial liabilities (such as liabilities from Sistema Nacional de Ahorro y Prestamos (SINAP) not included here.

Include banks and savings companies.

Adjusted for capital gains on previous stock issues.

Bank loans remained the most important source of domestic finance for the Chilean private sector (households and firms) during the period under study, averaging 79 percent over the entire period. The share rose during the years immediately after the debt crisis, peaking at 86 percent in 1985–86. Financial reform measures taken since 1986, including the new banking law, which limited permissible activities by banks, and the increased competition from other financial institutions lowered the share of bank loans in total domestic financing.10 Corporate bonds rather than equity—which by the end of 1991 had not reached its predebt crisis share in domestic financing—were the main source of domestic competition for bank loans during the period considered. As will be further discussed below, the emergence and rapid growth of private pension funds have played a crucial role in the surge in medium-term corporate bonds.

In contrast to the expansion of medium-term bonds, the market for commercial paper in Chile remains small and illiquid. This pattern diverges from that observed in a number of industrial countries, where corporations have been able to satisfy their demand for liquidity and their short-term financing needs directly in liquid securities markets.11

Notwithstanding the decline in the ratio of bank loans in total financing in recent years, the ratio remained high at 70 percent by the end of 1991. This finding is important in the Latin American context. Among Latin American countries, Chile’s banks probably face the greatest competition from other domestic financial institutions; that competition largely comes from private pension funds, which are only at an early stage of development in some countries (like Argentina and Peru) and nonexistent in most others. Therefore, the predominance of bank loans as a source of private sector finance in Chile reinforces the view that this feature is a Latin American phenomenon.

How does the role of banks in Latin America compare with that in industrial countries? Table 5 uses flow of funds data for Germany and the United States to show the ratio of bank loans to corporate domestic liabilities during the 1980s and 1990s. These two countries were chosen because they are often cited as representing the two extremes in the range of financial market structures in the industrial world. Germany represents the “universal banking system,” where banks face limited competition from other financial institutions, and the United States represents the “Anglo-Saxon” financial structure, where securitized money and capital markets compete with wholesale banks as sources of funds for the corporate sector.

Table 5.

Corporate Finance Structure in Germany and the United States

(Percent of total financial liabilities outstanding)

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Sources: Deutsche Bundesbank (1992); and United States, Board of Governors of the Federal Reserve System (1992).Note: Only domestic sources of finance are included.

Include commercial paper, loans from finance companies, and government loans.

Not surprisingly, a major finding is that the ratio of bank loans to domestic corporate liabilities in Germany was much higher than in the United States throughout the period under consideration.12 The average share of bank loans in Germany’s corporate liability was about 57 percent compared with an average of about 12 percent in the United States. Indeed, in Germany, private securities markets remain fragmented and relatively illiquid,13 and, at the short end of the market, there are very few domestic substitutes for bank loans. In contrast, commercial paper is among the preferred instruments for short-term financing by U.S. firms.

Although the Latin American experience is indicative of the predominance of banks as a source of finance, the discussion also shows that the importance of banks in domestic financial markets varies across countries. Indeed, some financial systems, such as Argentina’s, seem to be more bank oriented than, say, Chile’s. Because financial markets are still being reformed, there is a significant probability that a wide range of financial structures may emerge from the transformation. An important lesson emerges from the experience of the industrial countries, namely that, even in a highly integrated and global financial environment, alternative financial structures can coexist. There is no reason to believe that they cannot also coexist in Latin America.

Unique Features of Banks in Developing Countries

Gerald Corrigan, former president of the Federal Reserve Bank of New York, argues that banks are special because the bank charter gives them the unique power to provide means of payment in noncash transactions; this special power is called the franchise value of banks.14 When a bank customer withdraws funds from his or her bank deposit or writes a draft against that account, the bank delivers an “outside” asset, or “good funds”—namely, reserves on deposit at the central bank, or cash—to the customer or to the bank of the payee named on the draft.15

In fact, when other liability issuers promise to deliver payment, they promise to deliver bank deposits. Consider, for example, money market mutual funds in the United States, which invest in money market assets, such as commercial paper and treasury bills, and issue short-term claims on this portfolio to investors. When an investor wants to use money market mutual fund shares to purchase goods and services, the money market mutual fund must deliver funds from its bank deposit to the bank deposit of the payee designated by the investor.

Even though money market mutual funds must rely on banks to make payments for them, the markets for their assets have become so liquid that they can be sold for bank deposits immediately and at very low cost. Hence, the public is willing to hold money market mutual funds as perfect substitutes for bank deposits for some transactions.

In contrast, in developing countries, there are no issuers of perfect substitutes for bank deposits, such as money market mutual funds, because markets for such nonbank liabilities as commercial paper are illiquid. Commercial paper markets are illiquid because the accounting and legal frameworks are insufficiently developed to permit investors to evaluate corporate cash flow and their legal standing in the event of default for all but the most well-known firms; that is, investors cannot rely on the legal infrastructure to aid in evaluating the creditworthiness of most potential borrowers. Hence, the potential pool of issuers is not large enough to create a liquid market for nonbank short-term paper. Therefore, in developing countries, banks are not only the unique issuers of the means of payment, they are also the unique nongovernmental issuers of all liquid instruments.

In developing country markets, the only institutions that can credibly promise to deliver bank deposits are banks. Banks’ claim to deliver means of payments is more credible than claims of other liability issuers because banks maintain deposits at the central bank and have access to a central bank credit facility, usually referred to as discount window privileges.

The public in developing economies is willing to accept bank deposits as liquid liabilities because banks hold deposits at the central bank. If, however, banks borrowed excessively from the central bank to keep their deposits liquid, the economy would soon experience high levels of inflation, and the value of the bank franchise would be destroyed; that is, the special power conferred by the banking charter would be worthless because the bank liabilities would have lost their real value. Therefore, if the central bank wants to preserve the franchise value of the banking system, it must avoid lending large amounts of funds to banks on a sustained basis. To this end, the central bank must ensure that banks have procedures in place to monitor the ability of their loan customers to deliver cash. In a market with undeveloped accounting standards, this implies restricting borrowers to short-term loans and frequent calls for payment of principal, which effectively means that most investment projects will be short term. In addition, banks must use the tools at hand—namely, the threat to seize a firm’s bank deposits and freeze its ability to make payments—in order to en-force loan contracts. When a borrower gets into trouble, a bank must have established procedures to resolve problems quickly if it is to maintain its commitment to deliver cash against deposits.

In sum, a sound banking system is taken to mean one that is able to preserve its franchise value—that is, banks’ commitment to deliver good funds against their deposit liabilities. In a developing country, the banking system must effectively monitor the liquidity of its borrowers and, in the face of difficulties, quickly establish loan workout programs to restore defaulted borrowers to performing status.

Measuring the Franchise Value of the Bank in Developing Economies

When investors evaluate the quality of banks in developing countries, they confront the same obstacles that they face in evaluating nonfinancial firms: accounting data are often undependable guides to quality. For example, usual indicators of bank soundness in industrial countries, such as ratios of capital to assets and loan loss provisions to nonperforming loans, are often uninformative because banks are not subject to standard procedures for placing loans on nonaccrual status or deducting defaulted credits from capital and loan loss accounts. Hence, investors in developing countries must look for other ways to assess the quality of bank balance sheets.

A bank could convince investors that it is sound and, therefore, able to deliver good funds by holding a large amount of cash assets—cash and deposits at the central bank (reserves)—relative to its deposit liabilities. In other words, a bank could convert itself into a vault. If, however, banks were to act as vaults, they would have less incentive to press borrowers to remain liquid, and they would reduce the amount of credit supplied to borrowers for a given amount of deposits issued. In other words, the liquidity demands of investors would be met by holding cash assets in the central bank rather than by supplying credit to domestic borrowers in a form that forces borrowers to remain liquid. The market discipline imposed by banks on borrowers would be adversely affected.

As the evidence presented in the next section demonstrates, when banks do not discipline borrowers, the credit risk in the financial system increases. Some other institution, usually government related, ends up supplying credit without imposing discipline on borrowers. When borrowers default, bank depositors are often forced to absorb the losses through outright confiscation or through inflation. Hence, one measure of the quality of the bank franchise is the ratio of cash assets to deposit liabilities—a relatively high ratio represents a weak franchise.16 That is, the market discipline exerted by banks on borrowers—by requiring frequent delivery of good funds as a way to prove borrowers’ creditworthiness—is reduced. In this connection, exceedingly high reserve requirements may jeopardize the franchise value of banks.

A second and related measure of franchise value is the ratio of loans to assets. Banks that hold a high ratio of nonloan assets to assets—usually government bonds, development bonds, and central bank bonds—are not fulfilling their role of policing the liquidity of borrowers. When reserve requirements are high, issuers of bonds often use the proceeds to provide long-term credit to borrowers who are not able to use these funds efficiently. In addition, when banks hold a high portion of their assets in government-related bonds, bankers do not obtain the experience of helping private borrowers work their way out of credit problems. When credit crises occur, bankers tend to try to resolve them by expanding credit without establishing loan workout programs to ensure that the new credit is used to correct the deficiencies in the borrower’s business plan that led to credit problems in the first place.17

Central Bank and Franchise Value of Banking System

If a bank maintains low cash ratios and high loan and deposit ratios relative to assets, it must, as indicated above, ensure that its borrowing customers remain liquid. Even the best banks, however, cannot depend solely on their own loan customers for liquidity; they must have access to good funds through the banking system to satisfy temporary shortages of liquidity. Good funds take two forms: the interbank market for short-term funds and loans from the central bank.

In many developing countries, the interbank market is uncompetitive; hence, practically speaking, the central bank must play a pivotal role in maintaining bank liquidity. To fulfill this role, the central bank must take the same attitude toward the banks with which it has a lending relationship that the banks must maintain with their borrowing customers. That is, the central bank must ensure that the credit it extends to a bank for liquidity purposes is not used to provide credit to borrowers that are in default. The central bank must therefore play a major role in supervising banks or at least have access to the supervisory data collected by other agencies.18 In fact, a major benefit of having a banking system with a low ratio of cash to assets and a high ratio of loans to assets is that the central bank is forced to maintain a close supervisory relationship with its banks because it may be called upon to provide liquidity assistance.

Moreover, when banks maintain high cash ratios, the central bank ends up with a large balance sheet relative to deposits outstanding because the cash, in the form of either vault cash or reserves, is a liability of the central bank. The evidence presented in Section III for a number of Latin American countries suggests that when cash assets held by banks at the central bank were exceedingly large, the central bank took over much of the role of extending domestic credit from the banks.19 When the central bank operates as a bank that provides direct credit to the market, one of the most important checks on loan decisions is removed. As lender of last resort to banks, the central bank maintains an arm’s-length relationship with ultimate borrowers. Hence, it is in a position to criticize the lending decisions of banks. When the central bank lends directly to the market, it no longer has a supervisory role to play.

The experience of the central bank in acting as supervisor rather than as direct lender is a crucial determinant of how a banking system survives a systemwide banking crisis, as occurred in many Latin American countries in the 1980s. In a major crisis, the central bank has an important role in reviving confidence in the system, and, to perform this role, it usually finds itself in a position in which it must lend funds to banks with severe credit problems. To prevent this credit expansion from being viewed as inflationary, the central bank must establish a lending program to banks that creates incentives for bankers to work with their borrowers to improve their businesses rather than to provide new funds for projects with no economic value. In other words, investors must be convinced that the credit created by the central bank will lead ultimately to real revenue gains.

The credit created will lead to real revenue gains if bank stockholders have incentives to help borrowers with nonperforming loans regain solvency. If central bank credit is provided to banks at below-market interest rates and banks view this credit as an unlimited source of funds, they might use the low interest rate credit to cover the unpaid interest payments on nonperforming loans—which might even restore the spread they enjoyed when they funded through the market. This policy, however, would do nothing to create future real revenue gains. In fact, it would only lead to continuous central bank losses. Instead, the central bank must tie its subsidized credit to a program that provides bankers with incentives to work with borrowers so that nonperforming or restructured loans return to performing status. Central banks have devised several strategies to deal with this problem, and several of these will be discussed and evaluated in Section III.

If a central bank lacks credibility in its lending policies, it may find it desirable to signal to the market that it is willing to subject itself to constraints that encourage prudence. One such constraint is to permit the banking system to freely offer loans and deposits denominated in a hard foreign currency, such as the U.S. dollar, a policy known as dollarization. Because the central bank cannot extend credit in the foreign currency without borrowing that currency in the international marketplace, it is more likely to lend funds less carelessly than it would in the domestic currency, which it can create. If banks can maintain high loan and low cash ratios in their foreign currency portfolios, they will have the proper incentives to monitor their borrowers. For example, dollarization of a banking system may not be detrimental to an economy if it is the only means by which loans can be extended in a disciplined manner.

The next section describes how the strength of the banking payments franchise and the quality of central bank leadership were important determinants in quickly restoring public confidence in the financial systems in the five Latin American economies after the onset of the debt crisis in the early 1980s.

1

For a discussion of the role of banks in transition economies, see Blommestein and Spencer (1994).

2

The exception is Argentina, where the category “commercial banks” includes the Caja Nacional de Ahorro y Seguros, the Banco Hipotecario Nacional, and the Banco Nacional de Desarrollo (BANADE). BANADE was closed in May 1993. As re-ported in Morris and others (1990), assets of developing financial institutions in Argentina accounted for about 20 percent of total assets of the financial sector by 1987.

3

Typically, development banks are recipients of public funds and enjoy special privileges from the government.

4

Although Venezuela showed a similar trend by 1992, the recent banking crisis was followed by large injections of government funds into the commercial banks in early 1994.

5

Brazil is a noticeable exception to this trend. Market capitalization is defined as the market value of the equity of firms quoted on the stock exchanges.

6

For a discussion of the issues related to the rapid increase in market capitalization in a number of developing countries, see Feldman and Kumar (1994).

7

Data on market concentration are taken from International Finance Corporation, Emerging Stock Markets: Factbook (various issues).

8

Limited data for Mexico are also reported in Singh and Hamid (1992). The data show that during 1984–88, the top fifty manufacturing corporations listed on the stock exchange used equity as their most important external source of finance. However, this result is derived using financing flows rather than stocks and should therefore be viewed with caution as it may lead to serious misinterpretations of the Mexican financial structure. During 1984—88, restrictive monetary policies in Mexico had a significant impact on the availability of bank loans. Moreover, during that period, corporations in Mexico achieved almost no real growth. Thus, as the authors themselves concluded: “… in the peculiar circumstances of the Mexican economy in the mid–1980s, the Mexican corporations achieved relatively little growth; but of the growth that did occur, a large proportion of it was financed by equity” (p. 47). The point to be learned from this analysis is that in economies facing large variations in real economic activity and in the design of economic policies, conclusions regarding the corporate financial structure cannot be based on flow data, which may be temporary. The particular advantage of using stock data is that they dilute temporary fluctuations.

9

Corbo and others (1992) indicate their methodology may under-state equity funding, but the understatement is less severe than the overstatement that would arise if current market prices were used.

10

The recent increased access by a number of firms to international capital markets may be viewed as an additional source of competition to bank loans. This issue is discussed in Section IV.

11

See International Monetary Fund (1992) for a discussion of the trend toward securitization observed in industrial countries.

12

For a more detailed comparison between the financial systems in Germany and the United States, see International Monetary Fund (1992).

13

As reported in International Monetary Fund (1992), commercial paper programs in Germany started only in 1991. It is interesting to note, however, that notwithstanding the limitations of private securities markets in Germany, the government bond market is large and liquid.

14

See Corrigan (1991).

15

The unique role of banks as providers of “good funds” is analyzed in Garber and Weisbrod (1992).

16

In industrial economies, low liquidity ratios are often taken as an indicator of problems in a bank; this is because banks in industrial countries operate at much lower cash ratios than those in developing economies. It is necessary to use caution when applying, for developing countries, the same ratios used to assess banks’ performance in industrial countries. The ratio of cash assets to deposits has a completely different meaning when it reaches the high levels found in some developing countries.

17

Once again, an important difference needs to be taken into account when analyzing ratios in developing countries relative to those in industrial countries. In industrial economies, a high loan to-asset ratio can imply an unsound bank. However, the extremely low ratios found in some developing countries cannot be interpreted the same way as the moderately low loan-to-asset ratios of sound banks in industrial economies. The main reason is the quality of nonloan assets held by banks. In industrial countries, banks frequently hold bonds from highly rated companies or other high-quality assets.

18

Even in countries that supervise banks through other agencies, such as an independent deposit insurance system, a banking commission, or the ministry of finance, the central bank must have access to bank supervisors if it is to fulfill its role as lender of last resort.

19

The evidence indicates that, with the exception of Peru, banks held a high ratio of cash to assets only when they were subject to high reserve requirements.

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