Liliana Rojas-Suarez

Download (PDF, 159 KB) In a May 2008 speech at a forum organized by the Central Bank of Colombia, senior fellow Liliana Rojas-Suarez analyzes the effect of the global financial crisis on Latin America before an audience of high-level government officials. Drawing on points made in her forthcoming book, Growing Pains in Latin America, she argues that key actions taken before the crisis to switch to flexible exchange rates and avoid major disruptions in their domestic the banking systems have saved Latin America from what could have been even worse repercussions. Additional reforms are still needed, however—especially those that would enable the implementation of countercyclical fiscal policy to counteract the effects of adverse external shocks. Rojas-Suarez makes a similar case in a recent interview with CNN en Español in which she compares the actions during the crisis of U.S. Fed chairman Ben Bernanke to those of central bankers in Latin America. Growing Pains in Latin America: An Economic Growth Framework as Applied to Brazil, Colombia, Costa Rica, Mexico, and Peru will be launched in the fall. A Spanish-language edition, Los desafìos del crecimiento en la América Latina: un nuevo enfoque will be released in partnership with the Fondo de cultura económica

In an essay in November's LatinFinance magazine (subscription required), CGD Senior Fellow Liliana Rojas-Suarez questions how appropriate prudential financial regulation can be designed in Latin America to contain the risks from high external capital volatility. Her answer is that it can be done, but not with the current regulatory approach, which largely consists of efforts to directly control financial aggregates such as liquidity expansion and credit growth. Rojas-Suarez recommends an alternative "pricing-risks-right" approach that, she argues, can go a long way in limiting the adverse impact of high capital flow volatility on local financial markets. According to Rojas-Suarez, traditional prudential regulatory policies cannot effectively contain the problems associated with capital flow volatility because they do not take adequate consideration of the particular risk features of financial sectors in Latin America. The reliance on capital adequacy rations, therefore, has not been effective. A better approach would be to create incentives for financial institutions in Latin America to "price right" the risks inherent to their assets. Such an approach might go a long way to mitigate the adverse effects from capital account volatility. There are particular features that distinguish Latin America's financial markets, such as shallow financial intermediation with very small capital markets, the predominance of assets and liabilities with short maturity, and high volatility in key financial variables, including the deposit base. Rojas-Suarez argues these features reflect depositors' lack of confidence in domestic financial systems, which, in turn, makes these systems highly vulnerable to capital flow volatility.   A Two-Tiered Approach For the least financially developed group of countries, where no capital standard works because basic conditions are not in place, the challenge is to identify and develop indicators of banking problems that reveal the true riskiness of banks. Countries such as Ecuador, Colombia, Venezuela and Nicaragua could benefit from an approach that encouraged the public offering of uninsured certificates of deposit, and that published inter-bank bid-and-offer rates to improve the flow of information of bank quality. Additionally, these countries should encourage the process of financial internationalization; market depth can only be achieved if a diverse group of investors and users of capital allow the market to become less concentrated. For the second group of relatively more financially developed countries (such as Chile, and to a lesser extent, Brazil, Uruguay, Jamaica, Peru, Panama, and Trinidad and Tobago) the main recommendation is to design a capital standard that appropriately reflects the risk of banks' assets. There are two important policy recommendations for this group of countries. First, governments should adequately assess the risk features of their own liabilities when calculating capital requirements. Second, countries should develop risk-based regulations in loan-loss provisioning.

Mervyn King, governor of the Bank of England, called last week for radical reform of the International Monetary Fund. In a speech in New Delhi, King said that the IMF's role as lender of last resort was much diminished in part because middle-income countries have built up large reserves. To remain relevant, he said, the IMF must give large developing countries a greater say in its governance and analyze the balance sheets of rich countries as well as developing countries. CGD senior fellow Liliana Rojas-Suarez, an international finance expert who chairs the Latin America Shadow Financial Regulatory Committee and previously worked on Wall Street and for multilateral institutions, including the IMF, shares her views on the future of the Fund. Q: King said in New Delhi that the governance of the IMF should give greater voice to large developing countries, such as China and India. The U.S. supports increased representation on the IMF board and consolidation of European representation, with a single seat for the Eurozone countries. How important are these sorts of changes? A: Increased representation of key emerging market countries on the IMF board is essential. The days when countries would just follow IMF advice without questioning its appropriateness are long gone. The IMF is suffering a credibility crisis partly because of the widespread perception that its response to the East Asian financial crisis led to declines in output growth beyond what was necessary for crisis resolution. Credibility can only be regained if Fund’s advice is backed by a Board with significant representation from countries that may need IMF programs. Q: The Financial Times reports that Rodrigo Rato, the IMF's managing director (and a former finance minister of Spain), has been trying to build consensus for incremental reforms, including greater focus in the Fund's surveillance reports and a reform of voting rights. Is there a fundamental difference between King’s views on these issues and where the IMF seems to be headed? A: The most important differences between Rato's and King's proposals regarding the need for reform of voting rights relate to timing and degree rather than substance and it’s good to see a consensus emerging on the need for such reforms. However, there are important differences on the issue of reforming IMF surveillance. While Rato would like to improve the effectiveness of surveillance using current instruments, King calls for an overhaul of the process, with a more vocal IMF publicly stating early warning signals of inadequate country policies, especially when they generate risks to the global financial system. I think King has it right. Q: What about King’s assertion that the IMF’s role as lender of last resort is going to become less and less important? Rato argues that it has only been a few years since the people worried that the IMF was overstretched, with huge loans to countries such as Argentina, Brazil and Turkey. He warns that such needs could easily arise again. What’s your view? A: This is a crucial issue, and on this question my views are much closer to Rato’s ideas than to King’s. The last three years have been exceptionably favorable for developing countries: global growth has been healthy, capital inflows have been abundant and prices of commodity exports have skyrocketed. Of course there has been a drop in demand for IMF lending! Nobody goes to the IMF in good times! However, this unusually favorable environment will not persist forever. If we learned anything at all from the crisis episodes of the last two decades it is that capital flow reversals can be sudden and large, so large that even substantial foreign exchange reserves may not be enough to insulate countries from a sudden stop of external finance. Q: You worked as principal advisor to the senior economist at the Inter-American Development Bank and recently chaired a joint CGD/Latin America Shadow Financial Regulatory Committee working group that prepared a report on the future of the IDB. That report recommended greater IDB flexibility in responding to the challenges of globalization. Are there any parallels between the challenges facing these two organizations? A: Definitely. In fact, increased flexibility is more important for the IMF than for any other multilateral organization. The IMF’s main job is to ensure the stability of the international financial system; this role goes beyond country or regional boundaries. The big issue is avoiding unsustainable global imbalances. As we know from the current account balances of China and the United States, global imbalances can involve industrial countries, developing countries or both. IMF flexibility in a globalized world means complementing country surveillance with world surveillance. Since global developments evolve continuously, so should IMF country-specific policy recommendations and financial support. Q: King has called for the IMFs board to refrain from micromanagement. Instead of having a resident board, he suggests that the board should meet six times a year, with directors comprising senior finance ministry or central bank officials. Do you agree that the IMF management should be given greater latitude? A: Absolutely. Independence is especially important for surveillance and policy prescriptions directed to industrial countries. How often has an appropriate recommendation by IMF staff not been made public because of political constraints imposed by the Board? There is an obvious and useful analogy for thinking about this. The IMF appropriately tells countries to make their central banks free from political interference. The IMF is essentially the world’s central bank. Like national central banks, its job is to provide liquidity to control crisis episodes and avoid contagion. Seen this way, it is only natural to protect the IMF from political interference by a Board that largely represents the interests of a minority of its membership. Q: Some people argue that such reforms are desirable but politically impossible. A: I disagree! I think that reform is inevitable. This is not because I’m an optimist. It’s just a matter of time before the major players in the world economy realize that they cannot afford to be without an adequate surveillance mechanism for global financial stability.