Avoiding A Credit Bubble in Latin America: Unconventional Measures for Extraordinary Times (Wonkcast)

For now, the future for Latin America looks bright. Confidence is high throughout the region after a strong rebound from the global financial crisis. But large and possibly volatile inflows of capital could lead to a credit bubble if regulators don’t take steps now to slow the large flood of hot money. In this edition of the Wonkcast I interview three members of the Latin American Shadow Financial Regulatory  Committee (CLAAF), a group prominent South American economists who meet twice yearly to offer advice to the region’s regulators and policymakers. Our focus is the group’s latest statement, which urges unconventional measures for extraordinary times.My guests are Liliana Rojas-Suarez, CLAFF chair and a senior fellow at CGD;  Guillermo Calvo, professor at Columbia University and former chief economist at the Inter-American Development Bank; and Carmen Reinhart, a senior fellow at the Peterson Institute.Guillermo begins by saying it’s good news that capital is returning to Latin America—but he is quick to warn that the boom could end in a bust.“We are concerned that there is a lot of instability,” says Guillermo. “In the past, this has caused crises in the region that Latin American countries were not prepared for.”“The lending boom gets started with fairly good projects but as time goes on, the quality of lending will suffer,” says Carmen. “Putting a cap on the growth of loans is necessary to mitigate the overheating problem and the decline in quality of lending that could make boom end in bust.”Liliana notes a related concern: that foreign banks might transfer resources from their South American subsidiaries to solve liquidity shortages at home.“We recommend liquidity requirements be absolutely the same between domestic banks and branches and subsidiaries of foreign banks in good times,” says Liliana. “But if problems in the home offices of foreign banks mount significantly, the supervisors in Latin America need to have the capacity and willingness to actually impose supplemental liquidity requirements on branches at subsidiaries of foreign banks.”My guests admit that some of their recommendations are a bit unconventional. But as Latin American leaders struggle to navigate sudden inflows of capital, innovative prescriptions for maintaining financial stability are looking more and more appealing.“Necessity is the mother of invention,” says Carmen. “The surge in inflows is sufficiently large and sufficiently persistent that measures like we propose here will be finding favor among some countries soon.”  For more on the CLAAF recommendations, listen to the Wonkcast or see LIliana’s closely related blog post. Listen to the Wonkcast to hear to hear discussion of the CLAAF’s prescriptions and read their statement produced at this year’s meeting to see the group’s full list of recommendations.If you have iTunes, you can subscribe to get new episodes delivered straight to your computer every week. My thanks to Will McKitterick for his production assistance on the Wonkcast recording and for assistance in drafting this blog post.