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CGD’s work in this area focuses on strengthening financial systems in development countries through innovation and regulation.
Greater access for the poor to the formal financial system—including payments, savings, credit, and insurance—can greatly improve household stability and development prospects. CGD examines how to strengthen, broaden, and deepen financial systems in developing countries through innovation and regulation. We also study the effects of financial crises, to avoid and mitigate future shocks, and how developing countries can improve their business climates to spur inward investment.
Does openness in trade and the free flow of capital promote growth for the poor? In this new working paper, CGD president Nancy Birdsall describes asymmetries in globalization and their implications for poverty reduction. She argues that poor countries lack effective social contracts, progressive tax systems, and laws and regulations that rich capitalist societies use to manage markets so that free trade and commerce more equally benefit all. These asymmetries also exist at the global level, where poor countries are especially susceptible to the risks of free trade and the vagaries of volatile capital flows.
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.
How is America's debt of 22% of GDP and its $670 billion trade deficit sustainable? What are the challenges to the rest of the world as the US’ fiscal accounts and exchange rates adjust to correct this imbalance? In this important new book, CGD/IIE Senior Fellow William R. Cline argues that without a significant fiscal adjustment, the growing US foreign debt will put the US economy—as well as the world economy and developing nations—at risk. The National Journal calls the book "the most thorough and up-to-date look at the issue."
In this posthumously published working paper, Dick Sabot argues that the U.S. external deficit is putting at risk the welfare of poor people in developing countries. This accessible paper draws on a forthcoming book, The U.S. as a Debtor Nation, by William Cline, and has been updated to include Cline's latest results.
Traditional economic theory predicts that capital mobility and international trade will push the world's national economies to one income level. As poorer nations race ahead, richer ones should slow down. Eventually, theory says, national economies would reach equilibrium. The reality of the last few decades, however, defies this notion; most of the poorest economies continue to lag far behind. For 50 years, foreign aid has been the main way the international community has promoted economic development. Yet it has not proven to be a silver bullet.
Nigeria has $33 billion in external debt. The government has been trying unsuccessfully for years to cut a deal with creditors to reduce its external obligations but to date has only managed to gain non-concessional restructuring. The major creditors also have good reasons for wanting to seek a resolution, yet agreement has been elusive. Fortunately, there is a brief window of opportunity in 2005 to find a compromise that can meet the needs of both sides. This note briefly outlines a proposal for striking such a deal through a discounted debt buyback.
This is a joint posting with David Wheeler and Robin Kraft
When countries in Latin America or Africa descend into crisis, economists in Washington take a harsh view. Governments are forced to reduce spending in return for IMF rescue packages and in some instances, countries are even put on a cash-only budget. In the United States, we have a very different approach designed to minimize hardship of any kind -- the bailout.