Argentina’s Banking Sector in the

Nineties: From Financial Deepening

to Systemic Crisis
Guillermo Rozenwurcel and Leonardo Bleger

T
1. INTRODUCTION

HE first important attempt to liberalise financial markets in Argentina took

place between 1977 and 1981 and ended in a complete failure. Throughout
the eighties the degree of ‘financial repression’ oscillated, but interest rates
remained basically market-determined. However, the financial system continued
to experience significant distortions, mainly due to the extreme volatility of the
macroeconomic environment.
The implementation of the Convertibility Plan in March/April 1991 and the
drop in international interest rates gave a decisive thrust to the liberalisation
policy undertaken in mid-1989, which aimed to restructure the economy along
market-friendly guidelines. Also the establishment of a convertibility regime by
law, requiring the Central Bank to back the whole monetary base with foreign
exchange reserves, together with the adoption of a new charter for this institution,
drastically limited the scope of monetary policy and the Central Bank’s role as
lender of last resort.
While the Convertibility Plan was quite successful at dramatically reducing the
inflation rate, it also had other less desirable consequences on economic
performance. On the one hand, it accentuated the economy’s vulnerability to
external shocks. On the other, it contributed to the fragility of the domestic
banking system. As a result, it greatly amplified the fluctuations of the business
cycle.

GUILLERMO ROZENWURCEL is from Centro de Estudios de Estado y Sociedad and

Universidad de Buenos Aires. LEONARDO BLEGER is from Universidad de Buenos Aires and
Banco Credicoop, Buenos Aires. An earlier draft of this paper was presented at the 1996 Annual
Meeting of the AAEP (Argentine Economic Association). The authors are grateful for the
comments received there and for those of the anonymous referee. Guillermo Rozenwurcel also
thanks the support received from IDRC (Canada) and Mellon Foundation (USA).

ß Blackwell Publishers Ltd 1998, 108 Cowley Road, Oxford OX4 1JF, UK
and 350 Main Street, Malden, MA 02148, USA. 369
370 ROZENWURCEL AND BLEGER

Since the beginning of the Convertibility Plan the Argentine economy has
evolved through two contrasting phases. The first one, lasting until the Mexican
crisis in December 1994, was characterised by a swift growth in GDP which was
fuelled by huge capital inflows. The second phase, triggered by the abrupt
reversal in capital flows induced by the Tequila effect, plunged the economy into
a deep recession. Despite the remarkably fast normalisation of international
financial markets after the crisis, it took the economy almost a year and a half (up
until mid-1996) to begin to recover, albeit gradually and with a persistently much
higher rate of unemployment than during the pre-crisis period.
Taking this background into account, this paper tries to accomplish two main
goals. The first is to analyse the most important consequences of the reform
process on the structural and institutional features of the Argentine banking
system. Based on this analysis, the second goal is to understand why the Tequila
effect prompted such a deep financial crisis in Argentina, unlike the less
traumatic effects induced in all other major Latin American economies, and to
assess the main repercussions of this crisis.1
In order to acheive these goals, we will focus our analysis on the specific ways
in which a Currency-Board arrangement shapes the links between the
macroeconomic environment and the financial system. We think that this
perspective is quite relevant for at least two connected reasons. First, the
widespread debate on the opportunity of adopting similar schemes in several
emerging economies currently taking place both at the academic and policy
levels. Second, the fact that the Argentine case is crucial to empirically assess the
pros and cons of a Currency-Board scheme, because it is actually one of the
largest and most complex economies operating under such an arrangement.
The approach of the paper is basically macroeconomic. We do not therefore
discuss in much detail the micro fundamentals determining the behaviour of
banks during the liberalisation process and the ensuing financial crisis, though we
do point out some of its most salient features and provide the relevant references
supporting our assertions.
In our view, the emphasis on the macro side of the process is further justified
by what we think was the systemic nature of the Tequila crisis, which combined
massive capital outflows and a sharp monetary contraction triggered by a
‘contagion’ effect, with the Central Bank unable to deal with a systemic run on
bank deposits due to the constraints imposed on its policy actions by the
convertibility regime and its own 1992 new Charter. The remainder of this paper
is therefore structured as follows: Section 2 deals with the recent evolution of
Argentina’s banking system, Section 3 discusses the Tequila effect, and finally,
Section 4 concludes.

1
The evolution of Argentina’s monetary aggregates and other key macroeconomic indicators over
the first half of the current decade can be traced in Table 1.

ß Blackwell Publishers Ltd 1998

 ARGENTINA’S BANKING SECTOR IN THE NINETIES 371

2. THE EVOLUTION OF THE BANKING SYSTEM UNDER FINANCIAL

LIBERALISATION

Argentina has not been a typically ‘repressed’ economy since the liberalisation
attempt of the late seventies. In fact, although that experience ended in a
complete failure, many of the changes it produced in domestic financial markets
and the banking system proved irreversible. As a result, during the past decade
interest rates were basically market-determined; credit allocation was
increasingly decentralised; and the conventional goals of monetary policy were
mainly pursued through indirect policy instruments. But still, mostly as a result of
extremely high inflation and severe macroeconomic uncertainty, the economy
continued to experience massive financial distortions throughout the eighties.
The functioning of domestic financial markets, and the credit market in
particular, has changed dramatically since the early nineties because of the joint
impact of the CP and the current new attempt at financial liberalisation.
Accordingly, the primary purpose of this section is to analyse the most important
repercussions which this process had on the structural and institutional features of
the Argentine banking system, including its legal and regulatory framework, the
role of the Central Bank, prudential regulation, and the management of liquidity
and solvency problems. In order to do so, we present and discuss below the main
initial conditions and stylised facts of the banking system in the nineties:2

(a) Argentina’s banking system still displays a large number of

institutions and is physically oversized when compared with the
relatively reduced volume of funds it intermediates. Despite the
manifest inefficiency of the banking sector, the system revealed very
little evidence of structural adjustment during the initial
expansionary phase of the Convertibility Plan.

Demonetisation has been chronic in the Argentine economy since the late
fifties and it deepened even further during the debt crisis period. Nevertheless,
throughout the CP’s initial expansionary phase there was a sustained recovery in
the monetisation level. As a result, M2* jumped from five percentage points of
GDP in1990 to slightly over 20 per cent in 1994.
However, the level of financial intermediation (compared with the size of the
Argentine economy) is still not only well below that of developed countries, but is
also below that of other economies on a comparable level of development. Indeed,
all relevant measures of liquidity as a proportion of GDP are currently quite inferior
to those Argentina reached before the financial crisis in the early eighties.

2
See Rozenwurcel and Fernández (1994) for a more detailed discussion on the workings of the
Argentine banking system before the 1995 financial crisis.

ß Blackwell Publishers Ltd 1998

372 ROZENWURCEL AND BLEGER

TABLE 1
Main Macroeconomic Indicators

1990 1991 1992 1993 1994 1995 1996

GDP at market prices (3) 141.4 189.6 228.8 257.7 281.6 285.0 301.6
Real GDP growth (%) 0.1 8.9 8.7 6.0 7.4 ÿ4.6 4.4
Annual Inflation (CPI) 1343.9 84.0 17.5 7.4 3.9 1.6 0.1
Gross domestic investment (1) 14.0 14.6 16.7 18.2 19.9 18.1 19.1
National savings (1) 17.7 14.9 14.1 15.9 17.0 17.3 17.8
Real exchange rate (2) 100.0 75.0 61.3 56.2 54.5 54.6 55.7
Current account (3) 4.8 ÿ0.7 ÿ6.7 ÿ7.6 ÿ10.2 ÿ2.4 -3.5
Capital account (3) ÿ1.3 1.6 10.4 14.8 10.4 ÿ0.4 7.1
Trade account (3) 8.2 3.7 ÿ2.6 ÿ3.7 ÿ5.9 2.2 -3.7
Exports (3) 12.2 12.0 12.2 13.1 15.8 21.0 23.5
Imports (3) 4.0 8.3 14.9 16.8 21.6 18.7 21.9
Reserves (3) 4.6 8.0 11.0 15.3 16.0 15.9 19.7
M1/GDP (%) 2.1 4.3 5.2 6.0 6.1 6.7 7.7
M2/GDP (%) 3.8 7.4 9.5 11.8 11.9 11.1 13.0
M2*/GDP (%) (4) 5.0 11.1 14.4 19.0 20.0 19.5 23.1
Total external debt (3) 62.2 65.4 67.6 70.7 77.0 82.1 85.1(6)
Non-financ. public sector
deficit (1) 2.7 1.3 0.7 ÿ1.0 0.1 1.1 1.7
Primary deficit (1) ÿ1.4 ÿ1.7 ÿ2.2 ÿ2.2 ÿ1.0 0.5 0.3
Unemployment rate (5) 6.3 6.0 7.0 9.3 12.2 16.6 17.3
Notes:
(1) % of GDP – (2) WPI USA/CPI Arg – (3) bns. of US dollars – (4) includes dollar deposits – (5) in October
each year – (6) Sept.96.

Source: Based on data from the Central Bank and the Ministry of the Economy.

By contrast, the number of financial institutions and their houses functioning

in the domestic system is still sizable, despite a steady reduction as from the early
eighties. In fact, prior to the eruption of the most recent financial crisis in late
1994, there were still 205 financial institutions (168 banks plus 37 nonbanks),
while the number of branches reached 4,081.
Although the proportion of inhabitants per house is similar to that in
industrialised countries (8,000) it is inconsistent with Argentina’s lower degree of
monetisation and financial deepening. In effect, despite their important growth,
total deposits per branch registered just 11.2 million dollars in late 1994.3 Indeed,
the use of banking services by the Argentine population is extremely reduced
compared with that in developed countries, and even with that in similar Latin
American countries. Thus, while the ratio of sight deposits over M1 (a plausible
indicator of the level of ‘bankarisation’) is less than 50 per cent in Argentina, it is
63 per cent in Brazil and about 70 per cent in Mexico and Chile.

3
Total deposits per employee were quite modest as well: they amounted to barely 374,000 dollars
at the same date.

ß Blackwell Publishers Ltd 1998

 TABLE 2
Number of Institutions and Houses

Dec. 1980 Dec. 1991 Dec. 1994 Aug. 1995 Nov. 1996
Type of Institutions Inst. Houses Inst. Houses Inst. Houses Inst. Houses Inst. Houses

National Public Banks 4 695 6 931 6 907 4 594 3 553

Provincial and Municipal Public Banks 31 1.145 29 916 27 752 29 1.012 21 920

Total Public Banks 35 1.840 35 1.847 33 1.659 33 1.606 24 1.473

Nat. Private Banks 57 1.090 66 1.198 59 1.467 59 1.807

Foreign Banks 27 215 31 322 31 360 31 405 28 375
Cooperative Banks 44 799 38 842 12 524 8 350

Total Private Banks 179 1.999 132 2.211 135 2.400 102 2.396 95 2.532

Total Banks 214 3.839 167 4.058 168 4.059 135 4.002 119 1.005

Total Nonbanking Inst. 255 280 47 28 37 22 31 51 26 44

Total in the System 469 4.119 214 4.086 205 4.081 166 4.053 144 4.049
Source: ‘Indicadores del Sistema Financiero’ and ‘Estados Contables de las Entidades Financieras’, Central Bank.
374 ROZENWURCEL AND BLEGER

All this suggests that low productivity and inefficiency are still critical
problems in Argentina’s financial system. The combination of economic stability
and financial liberalisation brought about by the CP and the market-friendly
reforms did not propel the banking sector’s structural adjustment any further.
Given the still prevalent inefficencies in the system, this was somewhat
unexpected, at least for the policy makers.4
The failure of the banking sector to take advantage of such favourable
circumstances to endogenously start to reorganise, a step which was broadly
acknowledged as inevitable, strongly suggests that when it comes to restructuring
the financial system, market incentives alone may sometimes provide the wrong
signals, and that an active CB policy inducing mergers and takeovers may be
necessary.
Indeed, despite a strikingly fast growth in bank lending, originating both in the
rapid evolution of their deposits and their renewed access to foreign credit lines,
the initial economic boom prompted by the CP generated a massive excess
demand for loans.5 This excess demand, in turn, pushed the real lending rates up
to quite high levels and allowed banks to record significant profits in their books
though, as we will discuss later, it was probably at the cost of underestimating the
prospective burden of bad debts.
In sum, as is usually the case during credit booms, while the expansion in both
deposits and loans in that period was far from selective (illustrating once again
the importance of informational asymmetries and moral hazard issues in financial
markets), problem banks did not face major liquidity constraints and could easily
overlook their solvency problems. This probably helps to explain the persistence
of many poorly managed domestic banks before the crisis.6

(b) The traditionally tight constraints imposed by the domestic banking

system on prospective small customers clearly persisted after the
launching of the CP.

Limited access to bank credit and other financial services can seriously hinder
economic performance and even more so during a period of structural reform. An
excessive concentration of bank loans among borrowers is a clear symptom of
such a limitation. This was traditionally the case in Argentina, and it has
remained so since the beginning of the CP, despite the simultaneous rise observed
in total credit. As a result, over the last five years, the so-called ‘principal

4
See Machinea (1996).
5
As a matter of fact, from the beginning of the CP to the end of 1994, total bank credit grew at an
average annual rate of 31 per cent, while the average annual growth in bank loans to the private
sector was almost 40 per cent over the same period.
6
Stiglitz (1993), among others, underlines the distinct significance of widespread information
problems in underdeveloped financial markets.

ß Blackwell Publishers Ltd 1998

 ARGENTINA’S BANKING SECTOR IN THE NINETIES 375

TABLE 3
Share of Different Types of Institutions in Deposits and Loans (In percentages)

Type of Institutions November 94 July 95 October 96

Deposits Loans Deposits Loans Deposits Loans

National Public Banks 14.5 18.1 16.3 20.5 14.5 19.1

Provincial and Municipal
Public Banks 24.3 23.5 24.6 22.7 22.4 19.0
Private Banks 33.4 32.4 33.0 32.5 39.3 38.8
Foreign Banks 16.1 16.2 19.7 17.9 19.0 18.6
Cooperative Banks 10.4 8.2 5.7 5.3 4.1 3.3
Nonbanking Institutions 1.3 1.6 0.7 1.1 0.7 1.2
TOTAL 100.0 100.0 100.0 100.0 100.0 100.0
Source: Own calculations based on data from ‘Estados Contables de las Entidades Financieras’, Central Bank.

debtors’ of the system (that is, debtors with loans that surpassed 250,000 dollars
or who made up the list of 50 major debtors of any single financial institution)
concentrated on average over 60 per cent of total bank lending.
As was already discussed in (a), financial liberalisation, at least in the way it
was implemented in Argentina in the early nineties, failed to improve the
efficiency of the banking system. According to the available information, it also
proved insufficient to weaken the longstanding market segmentation between
large and small borrowers regarding both loan conditions and access to other
financial services.7

(c) Public banking retains a key position in the domestic financial

system.

Public banks played a decisive role in the period of import-substitution

industrialisation (ISI), replacing the virtually nonexistent domestic capital
markets as suppliers of long-term financing. Since the collapse of the ISI in
the mid-seventies, they have been immersed in a deep crisis. When the CP was
implemented, the smallest provincial public banks, in particular, had probably
already been technically bankrupt for quite some time. Most of them have since
been privatised, and the rest will soon follow suit. However, public banks still
play a very significant role in Argentina’s financial system. In effect, four of the
ten most important banks are public, including the largest two in the system.
A direct consequence of the weight public banks maintain in domestic
financial markets is that their problems strongly affect the overall financial
conditions in the real economy. On the other hand, the stability of Argentina’s

7
Market segmentation and the difficulties faced by small bank customers, in particular by small-
and medium-sized firms, in the domestic financial system are discussed in detail by Rozenwurcel
and Fernández (1994).

ß Blackwell Publishers Ltd 1998

376 ROZENWURCEL AND BLEGER

immature and volatile financial markets, as well as the financial needs of certain
activities and regions with very limited access to the private banking system, is
still likely to require some degree of public-sector participation in the domestic
financial markets.
The need for an active government involvement in the financial markets is
widely acknowledged in the literature. At present, there is hardly any dispute on
the importance of prudential regulations and the supervision of financial
institutions, though the extent and nature of other more direct ways of public
intervention is still higly controversial.
Given the distinctive nature of developing economies we think (together with
some authors such as Stiglitz, 1993) that when the human capital and an
institutional setting providing adequate incentives are available, the presence of a
few public banks in the financial system can improve the outcome of the
intermediation process. This may well be the case in Argentina where, at least in
principle, these conditions apply, and where financial liberalisation alone proved
not enough to face the challenges posed by sharp macroeconomic fluctuations,
the almost absolute lack of long-term financial markets, and the extreme
segmentation of existing ones.

(d) The new monetary regime sharply narrowed CB powers regarding

both the conduct of monetary policy and its capacity to deal with
potentially destabilising shocks. As a result, the financial system
became much more vulnerable to systemic risk.

In September 1992 a new CB Charter established the institution’s autonomy

from the Executive Power. It also granted the CB full responsibility for the
administration of monetary policy and the supervision of the financial system. In
practice, however, the government’s radical approach to stabilisation-cum-
structural reform sharply narrowed the scope of monetary instruments and the
institution’s ability to set up a proper safety net against unexpected shocks.
Specifically, the new regime stipulated that the CB should maintain freely
available reserves in gold and foreign currency to the equivalent of 100 per cent
of its monetary base. During the administration of the first CB Board a 20 per
cent maximum of these reserves could be made up of dollar-denominated public
bonds valued at market prices. As from the administration of the second Board,
which has since been appointed, this proportion was raised to 33 per cent.8
Consequently, in order to prevent the monetary base from growing without a
corresponding expansion in foreign reserves, the CB was only allowed to finance
8
However, for the time being it seems unlikely that the CB might actually approach the new ceiling
without severely impairing private expectations. In fact, even at the peak of the recent financial
crisis the authorities never let the backing of the monetary base with public bonds surpass 20 per
cent.

ß Blackwell Publishers Ltd 1998

 ARGENTINA’S BANKING SECTOR IN THE NINETIES 377

the national government through the purchase of Treasury bonds at market prices,
and to provide funding to financial institutions exclusively in situations of
transitory illiquidity and for very reduced amounts. Another step in the same
direction was the virtual elimination of deposit insurance.
The authorities claimed that this was the proper approach in dealing with
moral hazard problems and meant a step forward in the process of financial
deregulation. In fact, the absence of both a working deposit insurance scheme and
a lender of last resort left the financial system with no safety net and no doubt
contributed to propagating the Tequila crisis in Argentina, since it increased the
system’s vulnerability to systemic risk.9

(e) No matter how significant the improvement in the prudential

regulatory framework had been, banking supervision prior to the
crisis was still weak in Argentina.

While the convertibility regime certainly limited the CB’s regulatory powers,
the optimism prompted by the favourable international situation and the progress
of structural reform in the early nineties may have led to a somewhat light
approach to supervision and enforcement of banking prudential regulation prior
to the Tequila crisis. Thus, given that systemic financial turmoil seemed highly
unlikely, the monitoring and enforcement capacities of the supervisory authorities
were not strengthened as was required by the new policy regime.10
To be sure, the problem had very little to do with the suitability of the
regulatory framework itself. To the contrary, in 1992 a Supervisory Board of
Financial Institutions reporting directly to the CB president was created, and
stricter norms concerning capital adequacy, diversification of credit risks,
provisions for bad loans, and minimum auditing standards were adopted. In
addition, legal reserves were set at high levels.
Moreover, in some cases these norms became even harsher than those defined
in the original version of the Basle Accords.11 Thus, in the case of solvency
provisions, besides taking into account banks’ risk-weighted assets, as was
established by Basle I standards, additional capital requirements were imposed
according to their level of immobilisations and that of their lending interest rates
(penalising riskier strategies based on excessively high loan rates).
As a result, in December 1994 the stated capital/assets ratio in the Argentine
banking system was on average 16 per cent. This meant a far lower leverage than
9
For a theoretical analysis of safety nets in financial systems, see Dewatripont and Tirole (1994),
Larraı́n (1994) and Aglietta (1995).
10
This was certainly not an exclusively Argentine peculiarity. The same expectation confusion
arose in Mexico before the crisis. The issue is discussed in Frenkel (1995) and Dornbusch et al.
(1995) among others.
11
For a detailed description and critical assessment of the Basle Accords, see Davies (1995) and
Dewatripont and Tirole (1994).

ß Blackwell Publishers Ltd 1998

378 ROZENWURCEL AND BLEGER

that found in most other countries, either developed or underdeveloped, and was a
cost at least partly associated with the rigidity of the policy regime, particularly
with the lack of a lender of last resort.12
Some improvements were also made regarding the disclosure of more detailed
balance-sheet information by banks.13 However, in late 1994, more than three
years after the CB became independent and despite the improvements made in the
prudential regulatory framework, the supervisory authorities were not yet ready
to carry out full scale regular inspections in financial institutions according to
modern international standards.
As the crisis showed, a significant number of banks had been taking advantage
of this weakness not to fulfil even the most basic prudential regulations, nor to
accurately report their real situation to the CB. In this regard, some analysts have
suggested that the stated capital of many banks may actually be overestimated,
because an important fraction is likely to be eroded by provisions and write-offs
of bad loans currently in their portfolios.14
(f) The memories of protracted high inflation and the more recent
hyperinflation episodes imposed severe constraints on the financial
system’s performance.
In effect, past history matters a great deal to present performance. This is
reflected in at least four issues: monetary hysteresis, dollarisation, preference for
flexibility and portfolio diversification. After five years of increasing price
stability, demand for domestic financial assets and other banking services in
Argentina is still significantly lower than the pre-high inflation period and much
lower than in most other countries with comparable inflation levels. This shows
the existence of monetary hysteresis. At the same time, since the beginning of
convertibility the banking system has become even more dollarised than in the
past. Both developments tend to accentuate the vulnerability of the financial
system to macroeconomic shocks, and particularly to volatile capital flows.15
Other evidence of the inadequate development of the financial system is the
low average term-maturity of deposits. Although there has been a minor
improvement in this regard, time deposits are on average slightly longer than 30
days. Depositors are still strongly risk-averse, and consequently choose to keep
very flexible financial positions.
12
Since the Tequila crisis, the CB has even begun to take the necessary steps to include some of
the more recent Basle proposals regarding interest rate, liquidity and other market risks in capital
requirements.
13
On the importance of disclosure provisions, and also on the disincentives and difficulties faced
by small depositors to benefit from them, see Stiglitz (1993).
14
Based on this conjecture, Corrigan (1996) argues that a banking crisis was probably in the
making in Argentina even before the Tequila effect.
15
Calvo (1995) stresses this vulnerability as an important factor behind the 1994 collapse in
Mexico.

ß Blackwell Publishers Ltd 1998

 ARGENTINA’S BANKING SECTOR IN THE NINETIES 379

And finally, the massive capital flight caused by the turbulent macroeconomic
environment of the eighties had a permanent impact on the financial behaviour of
domestic agents, leading to a much higher international diversification of
domestic portfolios. Thus, it de facto integrated domestic financial markets with
international ones, drastically limiting the room for autonomy in monetary policy
by strongly increasing the sensitivity of portfolio choices to differentials in
expected returns between domestic and foreign assets.16

(g) Exchange-rate overvaluation plus a swift financial liberalisation led

to overindebtedness and financial vulnerability.

During the first stage of the CP, economic activity followed the typical course
observed in most stabilisation attempts based on fixed exchange rates. The success
of the plan, coupled with the steady progress in structural reform, induced a boom
in domestic absorption and a sharp rise in output, given the initial low level of
capacity utilisation. On the other hand, owing to price inertia, disinflation was not
instantaneous, thereby producing a significant exchange-rate overvaluation. This,
together with the swift implementation of trade and financial liberalisation, led to
growing trade and current account deficits.17 Both the expansion in absorption and
the external deficit were primarily financed by massive capital inflows, which
were channelled through domestic credit and capital markets, therefore
contributing to a fast build-up in private and public indebtedness.
As was the case with many other attempts at rapid financial liberalisation, like
the Southern Cone experiences in the late seventies, the mix of aggressive bank
lending with lax prudential supervision once again resulted in a dangerous
accumulation of bad loans and growing fragility in the financial system. This
process began well before the Tequila crisis. In fact, the incidence of
nonperforming loans in total credit for the whole convertibility period presents
wide discrepancies between different types of institutions.
In any case, after the Tequila crisis the share of bad loans in bank portfolios
grew considerably for all groups of institutions, and particularly so for the public
and private provincial banks (Table 4). Moreover, the figures most probably
conceal the full extent of the problem. Indeed, there are strong presumptions that
bank books systematically underestimated the incidence of bad loans.18

16
Calvo (1995) offers a similar argument, but referred to the behaviour of foreign institutional
investors to explain the swift porfolio change in the Mexican case.
17
See, among many others, Frenkel (1995) and Dornbusch et al. (1995).
18
In effect, even allowing for the severity of the recent crisis, the incidence of problem loans could
not have reached its 1996 levels in just twelve months. Moreover, credit costs for the pre-crisis
period strongly suggest a pre-crisis build-up in problem loans, while impressions gained through
informal discussions with individual banks point to the same conclusion (Corrigan, 1996).

ß Blackwell Publishers Ltd 1998

 380
TABLE 4
Nonperforming Loans as a Proportion of Total Financing (In percentages)

ROZENWURCEL AND BLEGER

Type of Institutions March 91 June 91 Dec. 91 June 92 Dec. 92 June 93 Dec. 93 June 94 Dec. 94 April 95 Sept. 96

National Public Banks 28.71 53.65 56.38 44.60 33.17 34.63 22.37 23.64 21.87 22.16 25.90
Provincial and Municipal
Public Banks 43.69 39.93 42.16 39.88 36.33 36.81 37.23 38.46 37.55 44.19 33.20
Private Banks in the Federal
Capital 9.32 6.77 5.34 4.76 5.62 6.36 6.53 5.89 6.26 8.15 11.60 (*)
Private Banks in the Interior 13.43 10.69 12.04 12.30 12.73 11.87 11.29 10.88 11.41 15.93
Foreign Banks 5.60 5.74 4.78 3.76 4.68 5.56 7.60 6.89 6.76 7.18 7.20
Nonbanking Institutions 8.09 6.96 6.43 7.36 10.61 13.36 9.75 8.91 8.44 14.72 16.90
Total in the System 25.16 36.95 37.29 27.97 22.69 21.73 17.28 17.06 16.05 18.53 18.20
Note:
As from June 1994 the figures include loans in categories 3 to 5 of the new loan rating adopted that month. (*) Private Banks (Total).
Source: Own calculation based on data from ‘Indicadores del sistema financiero’, Central Bank.
ß
Blackwell Publishers Ltd 1998
 ARGENTINA’S BANKING SECTOR IN THE NINETIES 381

TABLE 5
Interest, Country Risk, and Expected Devaluation Rates (In percentages, in annual terms)

Domestic IRR Libor Estimated Expected

Rate Bonex 89 Rate Country Risk Devaluation
(1) Rate Rate

1990 December 94.49 25.99 7.56 17.14 54.36

1991 March 207.74 19.58 6.50 12.29 157.34
December 19.83 10.17 4.38 5.55 8.77
1992 December 25.31 12.68 3.63 8.74 11.21
1993 December 8.67 6.33 3.50 2.73 2.20
1994 March 7.03 9.13 4.25 4.68 ÿ1.92
June 8.08 9.31 5.25 3.86 ÿ1.12
September 8.33 8.66 5.75 2.75 ÿ0.30
December 9.55 9.67 7.00 2.32 ÿ1.09
1995 January 10.65 11.09 6.63 4.19 ÿ0.40
February 11.64 14.89 6.44 7.94 ÿ2.83
March 19.38 13.81 6.44 6.93 4.89
April 19.07 12.50 6.31 5.82 5.84
May 15.54 9.91 6.06 3.63 5.12
June 10.83 9.93 5.88 3.83 0.82
July 10.24 10.12 5.88 4.01 1.09
August 9.16 9.73 5.88 3.64 ÿ0.52
September 9.22 10.47 6.25 3.97 ÿ1.13
December 9.17 8.92 5.53 3.21 0.23
1996 March 7.27 8.79 5.50 3.19 ÿ1.40
June 6.58 9.80 5.80 3.78 ÿ2.96
September 7.80 8.84 5.75 2.92 ÿ1.00
December 7.60 7.41 5.63 1.68 0.18
Notes:
(1) Interest rate on 30-day term deposits.
Source: Own calculation based on data from the Central Bank and ‘Carta Económica’.

(h) High operational unit costs and significant credit risks lie behind the
coexistence of wide spreads and low profits.

The sustained high level of country risk is one of the key variables explaining
the persistence of an appreciable spread between domestic and international
interest rates. On the other hand, convertibility has been truly effective at
producing a marked fall in expected devaluation (Table 5).19 In any case, the
Tequila crisis interrupted the declining trend in domestic borrowing rates and
prompted a substantial rise in both peso and dollar rates, which extended
throughout the first half of 1995.
Borrowing rates exceeding international ones and declining intermediation
spreads that still remained extremely large resulted in excessively high domestic
19
We take the difference between the IRR of Bonex (a dollar-denominated public bond) and the
LIBOR rate as proxy for country risk, and the spread between the average rate of peso deposits and
the IRR of Bonex as proxy for expected devaluation.

ß Blackwell Publishers Ltd 1998

382 ROZENWURCEL AND BLEGER

lending rates, especially in real terms.20 Wide intermediation spreads basically

originate in two factors: first, the high operational unit costs associated with the
physical oversize of the financial system, in relation to the low level of
monetisation and bankarisation of the economy; and second, the significant credit
risks connected with the heavy burden of bad loans in bank portfolios.21 It is
precisely because of the same factors, and despite the above-mentioned wide
margins, that average long-term profitability in the bank system is astonishingly
low.

3. SYSTEMIC RISK AND THE MACROECONOMIC IMPACT OF THE BANKING CRISIS

a. The Unfolding of the Crisis

The outbreak of the Mexican crisis in December 1994 had deep repercussions
on Argentina’s economy and financial system and it unleashed one of the most
serious financial crises in the history of the country. During the second quarter
of 1994, the decision taken by the Fed to raise short-term interest rates at the
start of that year had already produced a decline in capital inflows, harming
Argentina’s economic and financial performance. Additionally, the govern-
ment’s inability to fulfil the fiscal guidelines set in the Extended Facilities
Agreement with the IMF led the Government to discontinue the deal before
acceding to the final tranche of the loan. This decision had a negative impact on
the expectations of both local and foreign investors and placed Argentina in an
extremely vulnerable position.
In such a context, the Mexican devaluation was quickly felt across the local
financial system. The crisis was triggered by an initial massive withdrawal of
peso deposits in domestic wholesale banks.22 The fragility of these institutions
turned markedly worse with the interruption of the credit lines open to them in the
interbanking call market. This concentration of deposits in 30-day terms made it
possible for the run to proceed quite quickly. Investors feared that Argentina
would follow in Mexico’s footsteps and devalue the domestic currency. This
would have affected the dollar value of their peso deposits which were still
considerable.

20
It is worth noting, however, that the cost of credit exhibits strong disparities linked, among other
things, to the size and geographical location of borrowers. The most adversely affected are the
small- and medium-sized firms excluded from international financial markets. The large economic
groups, of course, are far less affected because of their access to foreign credit and, to a lesser
extent, to the local capital market.
21
Of course, exceedingly high real lending rates themselves have lately developed into one of the
causes of the growing weight of problem loans.
22
Most of the domestic wholesale banks had fluid contacts abroad but were potentially quite fragile
because of their relatively high leverage ratios.

ß Blackwell Publishers Ltd 1998

 ARGENTINA’S BANKING SECTOR IN THE NINETIES 383

Meanwhile, the mistrust that arose in response to the default of some

wholesale institutions spread to other segments in the market, particularly the
smallest public and private provincial banks. A repercussion of this mistrust was
the virtual disappearance of the interbanking market which was reduced to the
transactions of only a small group of leading banks. At the same time, the
hardening of international capital market conditions compelled large firms to
seek out financing in the local market. As a consequence, the access of small- and
medium-sized companies to bank credit was further rationed.
The CB’s initial reaction to the liquidity crisis included the following measures:
a significant cutback in reserve requirements; the granting of rediscounts and short-
term swaps backed with public bonds by the Central Bank (within the strict limits
imposed by its Charter); and the hurried creation of an emergency safety net to
assist the institutions with liquidity problems.23 In addition, institutions undergoing
difficulties were induced to agree to a takeover by more solid banks so as to avoid
liquidation and the consequent losses for its investors.
The national government responded just as quickly. In the first days of March
some aspects of the CB Charter were changed. These changes, providing the
monetary authority with more tools to confront the crisis, empowered the CB to
grant rediscounts and advances in larger amounts and longer terms in situations
of systemic crisis, and extended the maximum term of suspension of financial
institutions. They also authorised the bank to relinquish, transfer or sell the assets
it had acquired from the entities with liquidity problems.
At the same time, the monetary authorities tacitly allowed the forced rollover
of deposits by several institutions. While this step certainly undermined the
investors’ confidence in the system, it at least made it possible to restrict the
suspensions or liquidations of institutions, preventing the crisis from becoming
totally uncontrollable. However, these measures alone were not enough and only
served to lessen the run on deposits temporarily. In the first fortnight of March
there was an escalation in withdrawals which affected the majority of the
institutions, including some of the leading and most prestigious banks.
This time the change in private portfolios was not exclusively fuelled by
exchange-rate expectations but also by the risk of default on bank deposits, be it
for liquidity or solvency problems of individual institutions, or for the possibility
of an overall refinancing of bank liabilities, as had happened in 1989 under the
Bonex Plan. A series of rather untimely announcements by some top public
officials only increased investors’ fears.
By mid-March, the propagation of the crisis had already depleted the funds set
aside by the CB to support the financial system and forced the government to
announce a new Financial Programme expressly destined to obtain foreign

23
This instrument, to be managed by the BNA (Banco Nación), was intended to buy loan portfolios
of the troubled institutions.

ß Blackwell Publishers Ltd 1998

384 ROZENWURCEL AND BLEGER

funding and counteract the expectations of default by the public sector and the
financial system. This programme contained a renewal and extension of the
previous Extended Facilities Programme for an additional year, which meant
fresh money for the government to the amount of 2.4 billion dollars. Loans for a
total of 2.6 billion dollars from the World Bank and the IDB were also
announced, as well as the commitment of foreign and local investors to subscribe
to a new public bond (‘Bono Argentina’) for 2 billion dollars. The external loans,
together with the projected fiscal surplus, would be devoted to increasing foreign
reserves, to servicing the principal of the public debt due in 1995, and to
constituting two funds – the Trust Fund for Banking Capitalisation and the Trust
Fund for Provincial Development – to finance the restructuring of private and
provincial public banks, respectively.

TABLE 6
Interest Rates and Financial Spread
Annual Interest Rates on 30-day Peso Deposits and Loans (In percentages)

Nominal Nominal Real Real Financial

Lending Borrowing Lending Borrowing Spread
(prime rate) (1) (1)

1989 December 443.31 394.71 ÿ53.56 ÿ55.53 48.60

1990 December 274.25 124.68 ÿ39.49 ÿ63.67 149.57
1991 March 196.07 135.14 ÿ15.37 ÿ32.79 60.93
December 85.76 52.97 3.27 ÿ16.02 32.79
1992 December 32.12 11.62 11.14 ÿ6.05 20.50
1993 December 24.65 10.17 15.89 2.23 14.48
1994 March 20.80 7.06 17.23 5.78 13.74
June 24.21 8.12 20.59 4.97 16.09
September 25.68 8.35 21.20 4.48 17.33
December 26.80 9.55 22.04 5.44 17.25
1995 January 30.15 10.65 23.95 5.38 19.50
February 30.01 11.64 23.82 6.32 18.37
March 38.43 19.38 32.60 14.35 19.05
April 34.27 19.07 28.37 13.83 15.20
May 28.63 15.54 23.33 10.78 13.09
June 24.30 10.83 19.86 6.88 13.47
July 18.41 10.24 14.74 6.82 8.17
August 17.45 9.17 14.36 6.30 8.28
September 19.64 9.21 17.06 6.86 10.43
December 13.90 9.16 12.11 7.44 4.74
1996 March 11.39 7.27 11.17 7.06 4.12
June 10.81 6.55 10.92 6.66 4.26
September 13.21 7.76 12.98 7.54 5.45
November 11.84 7.53 11.39 7.10 4.31
Notes:
(1) deflated by the CPI.

Source: Own calculations based on data from the Central Bank and ‘Carta Económica’.

ß Blackwell Publishers Ltd 1998

 ARGENTINA’S BANKING SECTOR IN THE NINETIES 385

The announcements had an important influence on expectations, especially of

large investors. This could be seen in the considerable deceleration in the run on
deposits. In order to boost the confidence of small investors, a partial but
compulsory deposit insurance to be financed by the institutions themselves was
also established. However, because of the persistence of an acute uncertainty at
the political level, a full reversion of the downward trend in deposits could not be
achieved until after the presidential elections in the second half of May.24 By the
end of 1995 the most dramatic effects of the crisis had receded. In December
1995 the domestic financial system had already recovered almost all the deposits
lost during the bank run.

b. Stylised Facts and Main Outcomes

The previous section described the domestic financial crisis, stressing its short-
run impact on the evolution of monetary aggregates and interest rates, as well as
the behaviour of market participants and the monetary authorities during that
period. This section focuses on the crisis from a more analytical perspective,
trying to highlight its main causes, features, and consequences (both short- and
long-term). The following points develop this analysis in a stylised fashion:

(a) The crisis was basically the result of a macroeconomic external shock
– namely the Tequila effect – hitting an economy already exhibiting
weak fundamentals, including a particularly fragile banking system.

Even the most casual analysis would suffice to show that the crisis was not
simply a sectorial event which originated in the wrongdoings of some individual
banks. Rather, both the timing and depth of the crisis strongly suggest that it arose
from a macroeconomic external shock – namely the Tequila effect. The actual
motives for the investors’ panic before the shock, however, are a bit more
controversial. Was the bank run exclusively as a self-fulfilling prophecy, in no
relevant way connected with economic fundamentals as some authors would
argue, or were there some deeper reasons behind it?25 It is certainly true that a
sizable contagion effect was felt in several emerging markets, in particular in Latin
America, immediately after the Mexican devaluation in late 1994.26 However, in
almost all the cases these effects tended to dissipate relatively fast. By contrast, the
impact of the Mexican shock in Argentina was much deeper and long-lived.
All this suggests that in the Argentine case, no matter how important the
contagion effect may have been, there were most probably some additional
24
A more detailed account of the crisis can be found in Broda and Secco (1996).
25
Calvo (1995) can be taken as a good example of the first position, and Sachs et al. (1996) as a
good example of the second.
26
See, for instance, Calvo and Reinhart (1996).

ß Blackwell Publishers Ltd 1998

386 ROZENWURCEL AND BLEGER

factors behind the crisis as well. According to our previous analysis, these factors
appeared to stem mainly from the weaknesses of both the country’s
macroeconomic environment and its economic fundamentals. The former had
to do basically with the unsustainable combination of the economy’s growth
performance with a steadily accelerating current account deficit, while the latter
were primarily attached to the sizable distortions prevalent in the relative-price
structure (especially the exchange-rate overvaluation) and the conspicuous
fragility of the banking system.
In fact, it is rather easy to show in a simple macromodel admitting multiple
equilibria that, after an exogenous shock increasing the expectations of a
devaluation, an economy operating under a pegged exchange-rate regime would
undergo a currency crisis and adjust to a ‘bad’ equilibrium if, and only if, it had
weak fundamentals (be it either exchange-rate overvaluation, a fragile banking
system, or both) in addition to insufficient foreign reserves.27 Argentina was
precisly in that predicament when the Tequila crisis erupted.28 On the other hand,
if the economy had strong fundamentals, then such a shock would produce no
permanent effect.

(b) The pervasiveness of the banking system’s fragility in the eighties

was a predictable outcome of high inflation and extreme uncertainty.
What economic reformers in the nineties did not anticipate, however,
was that financial deregulation and liberalisation would not
automatically cure this problem but, if anything, would worsen the
system’s fragility.

We have already discussed in Section 2 the damaging implications that the

process of demonetisation, dollarisation and short-termism had, from the
viewpoint of fragility and systemic risk, for Argentina’s banking sector during
the eighties. While the early nineties’ process of financial liberalisation and
deregulation did not significantly alter the previous trends regarding either
dollarisation or short-termism, it did produce a dramatic reversal in the evolution
of monetary and credit aggregates. Although it may seem paradoxical, the very
speed with which the process of remonetisation and credit expansion proceeded
only increased the banks’ vulnerability to systemic risk.
On the one hand, the financial boom that took place in the first three years of
the CP allowed banks both to attract an ever growing flow of funds and to display
huge profits in their books, thereby delaying a much needed restructuring. Among

27
See, for instance, Sachs et al. (1996).
28
In fact, not only was the Argentine peso significantly appreciated and its financial system rather
wobbly, but the backing of the money supply (as measured by M2*) with liquid foreign reserves in
the CB and the commercial banks had sharply diminished, from 37.6 per cent in March 1991 to 25.1
per cent in November 1994.

ß Blackwell Publishers Ltd 1998

 ARGENTINA’S BANKING SECTOR IN THE NINETIES 387

other things, this delay prevented them from improving their competence in some
traditional banking functions such as screening, monitoring or hedging, which
were becoming more crucial for risk management as the economy was leaving
behind the prolonged period of high inflation. On the other hand, the new
institutional scenario brought about by the quasi-Currency Board regime, the
1992 Central Bank Charter and the modifications introduced into the Law of
Financial Institutions that same year undoubtedly accentuated the inherent
dangers of the myopic approach to adjustment which the banks chose. In fact, as
we have already argued in Section 2, some of the regulatory reforms introduced
in the nineties significantly increased the system’s fragility. The extreme
limitation of the CB’s lender of last resort functions (well beyond that imposed by
the Convertibility Law), the absolute absence of discretionary powers to assist
problem banks, and the elimination of the deposit guarantee were among the most
notable examples of this circumstance. A similar case can be made regarding the
somewhat loose attitude adopted by the CB towards banking supervision and the
enforcement of prudential regulation.

(c) The run on deposits triggered by the Tequila effect was clearly
crucial in the deterioration of the banks’ balance sheets, strongly
suggesting that the crisis was mainly of a liquidity nature. Its rapid
propagation, on the other hand, turned it into a systemic event.

It is often very hard to distinguish liquidity from solvency problems in the

financial position of fragile banks, especially as these problems are so closely
intertwined. Nevertheless, and despite the steady growth in the share of bad loans
in banks’ assets during the pre-crisis period, average solvency ratios were still
acceptable at the end of 1994. There is little doubt, therefore, that the 1995 crisis
would not have been activated had it not been for the massive deposit
withdrawals triggered by the Tequila effect.
The view that the crisis was originally of a liquidity nature is also supported by
the fact that the more solid small wholesale banks were able to outlive it by
gradually selling their positions in public bonds and high-grade corporate
securities. Sure enough, with the progression of the crisis the solvency of the
hardest hit banks began to deteriorate swiftly. On the other hand, despite the crisis
originating in the most vulnerable segment of the market (wholesale and
provincial banks), by March 1995 it had already spilled over into the rest of the
system, thereby turning into a systemic event.

(d) In order to face the crisis the economic and monetary authorities
were forced to introduce major changes in the credit and financial
policies applied during the first half of the nineties.

ß Blackwell Publishers Ltd 1998

388 ROZENWURCEL AND BLEGER

With the escalation of the financial crisis, the entire monetary and financial
scheme set up in the early nineties was put to the test. Reality quickly showed that
some of the basic traits of the new scheme could not adequately handle a systemic
crisis. Consequently, major modifications had to be made in the regulatory
framework in order to at least restore a minimum safety net with which to support
the banking system. This net included broader CB powers to finance troubled
institutions and to deal with problem banks, as well as a new deposit insurance
mechanism. The early nineties’ arrangements practically deprived the CB of its
faculties as lender of last resort. Accordingly, they extended a key role to legal
reserve requirements for the provision of liquidity in the face of a potential crisis.
Although the existence of high bank reserves prior to the crisis helped the
institutions to face its most immediate repercussions, it soon became clear that
they did not suffice to cover the increasing liquidity needs generated by the
spreading of the bank run. As a result, the authorities decided that the CB would
assist the financial system with all the funds available from the excess of its
foreign-currency reserves above the monetary base (including dollar-
denominated public bonds up to the limit allowed by the Convertibility Law),
thereby re-establishing its function as lender of last resort, though on a limited
scale. In order to do so, Congress sanctioned a modification in the CB charter
which broadened the bank’s power to grant rediscounts and advances in both
amounts and terms, as long as this did not affect the functioning of the
convertibility regime.
Neither did the provisions incorporated into the Law of Financial Institutions
in 1992 contemplate any official action to support the rehabilitation of problem
banks. In fact, they only specified that any entity facing solvency problems,
deficient liquid reserves or any other difficulty that would affect its functioning
had to undertake a regularisation plan, subject to CB approval. Its nonfulfilment
implied automatic liquidation of the institution.29
The strict application of these norms would have forced the liquidation of a
major number of entities and would have made it impossible for the monetary
authorities to handle the crisis. Thus, the charter was modified so as to extend the
suspension term of an institution: after the first thirty days have expired, the
suspension can be renewed for up to ninety days.
The Law of Financial Institutions was also revised in the chapter on bank
restructuring. In the event that an entity experiences severe solvency
difficulties, these modifications would give the CB the power to act in order
to protect the interests of both bank depositors and borrowers, either through
takeover of the floundering institution or by inducing the sale of a portion of its

29
In fact, there were no solid theoretical arguments in favour of this stance, which also ran against
most of the accumulated international experience in the field. On this issue see, for instance,
Dewatripont and Tirole (1994).

ß Blackwell Publishers Ltd 1998

 ARGENTINA’S BANKING SECTOR IN THE NINETIES 389

assets and liabilities to a more solid institution in the system. The healthier
institutions’ interest in participating in the rehabilitation process was enhanced
by the CB’s decision to forbid the opening of new bank branches. With regard
to deposit insurance, there is little doubt that, to some extent, the absence of
such a scheme contributed to propagating the Tequila crisis in Argentina.
Therefore, to rectify the government’s previous mistake and recover the
confidence of small depositors, Congress was urged to enact a law creating a
new deposit insurance.
As a result, a Deposit Guarantee Fund was created, to be administrated by
Sedesa, a corporation made up by the banking sector under the supervision of the
CB. The funding of the insurance would originate in monthly payments by all
banks, proportional to the amount of their deposits. The coverage extended to all
deposits in domestic or foreign currency up to 10,000 pesos for checking and
savings accounts and for term deposits of under 90 days, and up to 20,000 pesos
for longer terms.
As an indirect regulatory mechanism of borrowing rates, designed to limit the
moral hazard inherent in any deposit guarantee regime, it was also established
that the deposits whose interest rates exceeded that determined by the BNA for
the same type of deposit by two percentage points would not be insured.30
Despite its low ceiling by international standards, the new scheme formally
covered 74 per cent of the deposit certificates in pesos and 55 per cent of the
certificates in dollars, positively affecting the confidence of small investors.31

(e) There is little doubt, however, that overcoming the crisis would have
been even more costly had it not been for the foreign rescue package
promptly set up under the coordination of the IMF.

The recovered CB powers to assist distressed banks, though certainly

necessary, arrived too late and were too modest to stop the crisis, only helping
to lessen the run on deposits temporarily. By mid-March, the propagation of the
crisis pushed the government to quickly devise a more comprehensive Financial
Programme expressly destined to obtain foreign funding and counteract the
expectations of default by the public sector and the banking system. The foreign
assistance and, in particular, the Fund’s active involvement were not incidental
factors in the resolution of the crisis. Instead, they were decisive in limiting the
harm it provoked.

30
On this issue, see Glaessner and Mas (1995) and Dewatripont and Tirole (1994).
31
It is interesting to note, however, that real possibilities of coverage were initially virtually nil
given the meagreness of the Guarantee Fund. In fact, the scheme stipulated that when the
accumulated resources could not cover the commitments, reimbursements would be made on a pro
rata basis from the available funds.

ß Blackwell Publishers Ltd 1998

390 ROZENWURCEL AND BLEGER

TABLE 7
Concentration of Deposits in the Largest Banks
(In percentages over the total of the banking system)

Dec.79 Dec.85 Dec.90 Dec.94 March 95 July 95 Oct.96

5 largest 27.7 42.5 41.2 37.0 39.9 42.7 38.4

10 largest 40.2 54.6 54.1 50.6 54.5 58.1 58.4
20 largest 56.6 66.7 67.8 65.3 69.4 72.8 75.0
Remainder 43.5 33.4 32.2 34.7 30.6 27.2 25.0
Source: Own calculations based on data from ‘Estado de las Entidades Financieras’ and ‘Estados Contables de
las Entidades Financieras’, Central Bank.

(f) The liquidity squeeze was almost fully reversed at the end of 1995. The
extent of the crisis, nonetheless, fostered a sharp acceleration in market
concentration and a full-scale restructuring in the banking system.

Even though the crisis had subsided significantly by the end of 1995, it had
lasting repercussions on the structural and institutional configuration of the
financial system. The number of financial entities was reduced from 205 to 166
between December 1994 and August 1995. This reduction was due principally to
mergers and takeovers since only nine financial institutions were liquidated
during the crisis. This explains why total branches only diminished from 4,081 to
4,053 during that period (Table 2).
Considering the distribution of deposits by type of institution, the most
significant changes were the growth in national public banks and foreign
institutions, and the fall in cooperative banks (Table 3). Likewise, the share of
total deposits in the largest banks evidenced a huge jump (Table 7). This trend
was even more striking in the private banking segment (Table 8). As a result,
banking concentration accentuated abruptly.
This redistribution of deposits from the smallest cooperative and provincial
public banks to the largest private institutions, especially the foreign ones, and to
the national public banks suggests that, when deciding which banks still deserved
their trust, investors cared much more about size or ownership than about
operational efficiency. Though rational from their viewpoint, this reaction is
probably reinforcing the already extreme segmentation of the domestic financial
market and the insufficient credit support received by small- and medium-sized
borrowers, given that the large private banks, particularly the foreign ones,
earmark a proportion of their financing that far surpasses the average in the
system to large companies.32

32
In fact, the figures for August 1996 show that while the total bank credit outstanding was
distributed among 3,716,058 loans, more than one-third of that total was channelled through only
1,458 loans which received four million dollars or more each, and about a half was channelled
through 6,357 loans which obtained one million dollars or more each.

ß Blackwell Publishers Ltd 1998

 ARGENTINA’S BANKING SECTOR IN THE NINETIES 391

TABLE 8
Concentration of Deposits in the Largest Private Banks
(In percentages over the total of the private banking system)

December 90 December 94 August 95 October 96

5 largest 33.0 34.0 41.0 42.2

10 largest 50.0 50.0 61.0 57.6
20 largest 66.0 66.0 78.0 76.3
Remainder 34.0 34.0 22.0 23.7
Source: Own calculations based on data from ‘Estado de las Entidades Financieras’ and ‘Estados Contables de
las Entidades Financieras’, Central Bank.

This current trend towards a much higher level of concentration and

denationalisation in the banking system prompted by the 1995 financial crisis,
while certainly strengthening the solvency of the system, is likely to accentuate
some of its current shortcomings, particularly regarding credit allocation in regional
and sectoral terms (Cañonero, 1997). This has led economists from different
theoretical traditions to reconsider the potential role of a small and efficient public
banking sector in Argentina’s financial system (González Fraga, 1997).
On the other hand, the need to fulfil stricter capital requirements (in relation to
the size of their assets), as well as to make substantial reductions in their
administrative costs, have created severe problems for a major number of small-
and medium-sized institutions, which still maintain a high level of indebtedness
with the Central Bank. Moreover, the solvency indicators of several of the new
institutions resulting from the mergers and acquisitions accomplished in the midst
of or immediately after the crisis, are definitely worrysome.33 Also, the tendency
away from banking intermediation, particularly intense in the large companies,
and the arrival of many foreign investment banks, have sharply narrowed the
outlook for the domestic banks which centre on wholesale activities. The main
implication of this analysis is, of course, that the restructuring of the banking
system is far from completed.

(g) The CB has recently adopted several policies to limit systemic risk.
Nevertheless, the fragility of the domestic financial markets is still
considerable.

One important lesson the Central Bank certainly drew from the 1995 crisis was the
need to follow a preventive policy against systemic risk. Acting accordingly, it has
recently determined a progressive increase in the banks’ minimum liquidity
requirements. In November 1996 it also hardened the system’s prudential regulations,
establishing the so-called BASIC scheme. This new prudential framework intends to

33
See Machinea (1996).

ß Blackwell Publishers Ltd 1998

392 ROZENWURCEL AND BLEGER

complement the CB’s traditional regulatory functions with some market mechanisms.
In order to do so, besides reinforcing the CB’s supervisory powers and including
stricter controls on the banks’ external auditing firms, the new framework plans to
offer the public more complete information on the banks’ performance, and it also
demands that the banks be rated by an accredited private rating agency. Furthermore,
according to the new scheme, the banks will have to issue and float its own bonds as a
way to have a continuous market evaluation about their prospects.
On the other hand, in December 1996 the CB signed an innovative swap
agreement with thirteen large international banks which will operate as an
insurance mechanism against speculative attacks. The arrangement lasts two to
five years according to the individual deals reached with the different banks, and
it allows the CB to raise up to six billion dollars (about ten per cent of total
deposits in the domestic banking system) by selling public bonds, subject to a
repurchase agreement, to the banks involved. The swift recovery in the CB’s
liquid foreign reserves and the resulting improvement in the backing of the
money supply, initially prompted by the implementation of the foreign rescue
package and later sustained by the favourable evolution of the world financial
markets, also contributed to limiting systemic risk.
Despite these policy actions and the ongoing structural changes in the domestic
credit markets, certain indicators suggest that the system’s fragility remains
significant. In the first place, the sharp recession induced by the crisis provoked a
sizable increase in bad loans, clearly indicating that the solvency of many
institutions had further deteriorated. Although the share of problem loans has
somewhat diminished since the recovery initiated in the second half of 1996, it is
still too high, especially in the weakest banks.34 In the second place, the risk
posed by the maturity mismatches in banks’ assets and liabilities is still rampant.
The same judgement is valid for the far-reaching dollarisation of financial
intermediation, even though in this case the risk does not necessarily emerge as a
result of a mismatch in the currency denomination of deposits and loans. Instead,
it basically arises from the distinct possibility of an unexpected divergence in the
evolution of the incomes of a significant proportion of bank borrowers and the
exchange rate. In fact, such a possibility could materialise not only as a
consequence of an unanticipated nominal devaluation, but also as an outcome of
price deflation. In any case, the resulting real devaluation would certainly

34
In September 1996 the aggregate ratio of bad loans to total credit in Argentina’s financial system
was 18.2 per cent. The ratio was somewhat lower but nonetheless quite impressive in the national
private banks’ segment: 11.6 per cent (Table 4). On the other hand, according to Dick (1996), in
December 1995 the same ratio was 5.8 per cent for Argentina’s ten largest banks, while it was only
0.8 per cent in Chile (for the entire system) and also in the US (41 largest banks), 1.5 per cent in
Canada (5 largest banks), 1.9 per cent in Germany (3 largest banks) and 4.2 per cent in the UK (8
largest banks). The only case in the sample where the ratio was higher than in Argentina’s ten
largest banks was in Spain’s seven largest institutions (6.3 per cent).

ß Blackwell Publishers Ltd 1998

 ARGENTINA’S BANKING SECTOR IN THE NINETIES 393

increase the debt burden of bank borrowers and, if the shock is deep enough, it
would also impair the solvency of the creditor banks. In the third place, despite
the fact that a deposit insurance is in effect, the Guarantee Fund counts with an
almost insignificant volume of resources, which makes the efficacy of the
instrument somewhat doubtful should it be necessary.
Moreover, from a more general perspective, it remains true that under the
current monetary regime the CB retains very limited available instruments with
which to confront a systemic banking crisis.35
Finally, the possibility of further assistance from the multilateral financial
institutions, at least in the near future, is very restricted, given the profuse use of
these resources during the recent crisis. On the other hand, even though a new
IMF facility to deal with financial crises in emerging countries is currently under
discussion, it is not at all clear if and when it will be approved.

4. CONCLUSIONS AND POLICY LESSONS

The early-nineties’ liberalisation process has led to significant structural

transformations in the domestic financial markets and the banking system. The
most positive developments were an important increase in monetisation and
financial intermediation, the reversal in capital flight and the lifting of the foreign
credit rationing faced by Argentina in the eighties.
However, other developments have not been all that favourable. First, while
the process of remonetisation and financial deepening has been truly fast, the
demand for domestic financial assets and other banking services is still much
lower than in the period prior to the high-inflation seventies and eighties. Second,
dollarisation and its related risks have also deepened. Third, there has been no
significant lengthening in the term maturity of the banks’ liabilities. Fourth, the
system’s operational inefficiencies, largely accountable for the wide spreads and
commissions charged by the banks, still determine the persistence of quite high
real lending rates.36 Lastly, the small- and medium-sized firms, with almost no
access to foreign credit markets, continue to face a tight credit rationing in the
domestic markets too.

35
In fact, even though the Trust Funds are currently in force, they cannot be used to face liquidity
problems since, in principle, they are specifically destined either to the privatisation of public banks
or the capitalisation and restructuring of private institutions.
36
A recent Banco Central (1997) paper estimates as 12.4 per cent the annual average spread in
Argentina’s banking system at the end of 1996, much higher than that calculated for the US, which
was 5.2 per cent. The paper finds that the main factors behind such a huge difference were
Argentina’s higher operational costs (which explained 4.3 points of the spread in that country
against 1.1 points in the US), larger provisions (explaining 5.5 points of the spread in Argentina and
2.1 points in the US), and higher taxes (1.9 points and 1.1 points respectively).

ß Blackwell Publishers Ltd 1998

394 ROZENWURCEL AND BLEGER

Moreover, the combination of a completely unrestricted financial opening with

a quasi-Currency Board regime threatened the stability of the banking system. In
fact, while it first served to stimulate capital inflow and boost domestic activity, it
later facilitated the swift capital flight which accompanied the run on deposits
once the financial crisis had been unleashed as a result of the Mexican
devaluation. The recent crisis also illustrated the rigidity of the current exchange-
rate regime to absorb external shocks, the fragility of the domestic financial
system and the lack of a suitable safety net with which to confront a bank run.
Following the same logic that had led to the implementation of convertibility,
the government was convinced that legally preventing discretionary monetary
policies would have such favourable consequences on investor expectations and
moral hazard that no policy tools would be necessary to face a potential systemic
crisis. The eruption of the financial crisis clearly proved how weak this logic was
and forced the government to make urgent modifications to recover the policy
instruments available within the narrow confines of convertibility.
It is worth stressing, incidentally, that all regulatory changes took place in an
evironment where the full autonomy of the CB as established in the new Charter
was sharply reduced, since the depth of the crisis forced the Ministry of the
Economy to take charge. At any rate, despite the fact that the anti-crisis
instruments were recovered and utilised with a certain degree of efficacy, it was
the external support, achieved with the crucial backing of the IMF, that finally
made it possible to fully overcome the crisis by decisively improving
expectations on the maintenance of convertibility, the fiscal balance and the
soundness of the financial system. The crisis also hastened the ongoing structural
changes in the banking system, acting as a catalyst for the inevitable restructuring
of the financial institutions. As we have already seen, however, this process is far
from completed.
Therefore, while it is true that the system’s stance is more solid than before the
crisis, it would not be wise to completely dismiss the possibility of further
systemic complications. Both the multilateral institutions and the national
government seem to have recognised this point. In order to face it, and according
to the currently prevailing mainstream international consensus, the Central Bank
has recently hardened the system’s prudential regulations.37 On the other hand, in
December 1996 the CB signed a swap agreement with thirteen international
banks which will operate as a privately funded safety net. At the same time, the

37
Morris Goldstein from the Institute for International Economics, for instance, has recently
suggested that Central Banks in emerging economies should adjust prudential regulations to the low
level of development of their financial markets and institutions. This means, among other things,
setting a minimum 12 per cent capital-adequacy ratio, much higher than that established by the
Basle Accords, adopting stricter criteria for the identification of bad loans and their provisioning,
and stipulating that the performance of each bank be periodically evaluated by an internationally
credited rating agency.

ß Blackwell Publishers Ltd 1998

 ARGENTINA’S BANKING SECTOR IN THE NINETIES 395

CB is actively promoting a second round in the process of mergers and

acquisitions, with the explicit purpose that this time the resulting new institutions
be positively solvent.
In any case, within the tight limits imposed by the convertibility regime, a less
vulnerable financial system is likely to require not only very high bank reserves
and a much stricter regulatory framework, but also fewer and larger institutions
and a greater participation of foreign banks.38 This is particularly the case
considering that so far the proposals to widen the functions of the IMF, so that it
can systematically play the role of lender of last resort before a financial crisis in
an emerging country, do not seem to have attained the support of the
industrialised world.
There are some signs that the financial system may already be heading in that
direction. While such a trend will hopefully reduce systemic fragility, the risk that
it will further strengthen the market segmentation and restrict the access to bank
credit is certainly high. Therefore, the relevant question of how to ensure that this
system is also consistent with a sustained and equitable economic growth remains
open.

REFERENCES

Aglietta, M. (1995), ‘Globalización financiera, riesgo sistemático y control monetario en los paı́ses
de la OCDE’, Pensamiento Iberoamericano, No. 27.
Banco Central (1997), ‘Presentación sobre la coyuntura del Sistema Financiero’ (Mimeo, Buenos
Aires).
Broda, M. and L. Secco (1996), ‘Caja de Conversión pura o un Banco Central con lı́mites estrictos?
Las ventajas de la flexibilidad durante la crisis del primer trimestre de 1995’ (Anales de la
XXXI Reunión Anual, AAEP-UNS, Salta).
Calvo, G. (1995), ‘Capital Flows and Macroeconomic Management, Tequila Lessons’ (Mimeo,
presented at the Seminar on Implications of International Capital Flows for Macroeconomic and
Financial Policies, IMF, Washington, DC).
Calvo, G., L. Leiderman and C. Reinhart (1992), ‘Capital Inflows and Real Exchange Rate
Appreciation in Latin America: The Role of External Factors’, IMF Working Paper 92/62 (IMF,
Washington, DC).
Cañonero, G. (1997), ‘Bank Concentration and the Supply of Credit in Argentina’, IMF Working
Paper (IMF, Washington, DC).
Corrigan, G. (1996), ‘Building a Progressive and Profitable National Banking System in Argentina’
(Report to the Ministry of the Economy).
Davis, P. (1995), Debt, Financial Fragility and Systemic Risk (Clarendon Press, Oxford).
Dewatripont, D. and J. Tirole (1994), The Prudential Regulation of Banks (The MIT Press,
Cambridge, Mass).
Dick, A. (1996), ‘Costos y eficiencia bancaria en la Argentina’ (Mimeo, presented at the Jornadas
de Economı́a Monetaria y Sector Externo, Central Bank, Buenos Aires).
Dornbusch, D., I. Goldfajn and R. Valdés (1995), ‘Currency Crises and Collapses’, Brookings
Paper on Economic Activity, 2.

38
In fact, these are some of the recommendations proposed in Calvo (1995).

ß Blackwell Publishers Ltd 1998

396 ROZENWURCEL AND BLEGER

Frenkel, R. (1995), ‘Macroeconomic Sustainability and Development Prospects: Latin American

Performance in the 1990s’, Discussion Paper 100 (UNCTAD, Geneva).
Glaessner, T. and I. Mas (1995), ‘Incentives and the Resolution of Bank Distress’, Research
Observer (The World Bank, Washington, DC).
González Fraga, J. (1997), ‘La Privatización del Banco de la Nacion Argentina’, La Nación
(Buenos Aires).
Larraı́n, C. (1994), ‘Modernización de la Supervisión Bancaria’, Revista de la Cepal 54 (CEPAL,
Santiago de Chile).
Machinea, J. (1996), ‘La crisis financiera argentina de 1995: causas, caracterı́sticas y lecciones’
(Mimeo, Buenos Aires).
Rozenwurcel, G. and R. Fernández (1994), ‘Strengthening the Financial Sector in the Adjustment
Process: The Case of Argentina’, in R. Frenkel (ed.), Strengthening the Financial Sector in the
Adjustment Process (IDB- The Johns Hopkins University Press, Washington, DC).
Sachs, J., A. Tornell and A. Velasco (1996), ‘Financial Crises in Emerging Markets: The Lessons
from 1995’, Brookings Papers on Economic Activity, 1.
Stiglitz, J. (1993), ‘The Role of the State in Financial Markets’ (Mimeo, presented at the Annual
Bank Conference on Development Economics, The World Bank, Washington, DC).

ß Blackwell Publishers Ltd 1998