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Sound Banks for Healthy Economies in Latin America and the Caribbean Working Group
The COVID-19 crisis has been an unprecedented shock to health and economic activity worldwide. Latin America and the Caribbean has been hit particularly hard, with an expected loss in GDP for 2020 of 9.4 percent, according to the International Monetary Fund. Policymakers in the region have been active, meeting the increased demand for liquidity and designing and implementing programs to support firms and families. Some of these programs have involved the local banking systems. However, although banks are well placed to help families and firms by channeling credit, the region remains underbanked, and financial institutions face numerous challenges. In particular. The deep recession, of uncertain duration, caused by the pandemic will quite likely lead to important increases in non-performing loans. Elevated credit risk might sharply reduce the availability of bank credit, generating a vicious circle between credit and economic growth.
When the COVID-19 crisis hit Latin America and the Caribbean, the banking system was in a relatively strong position. After the crises of the 1990s, countries had implemented macroprudential policies, and many were in the process of adopting Basel III to improve the quality of bank capital and introduce additional buffers. However, the region also faced significant vulnerabilities that are now exacerbated. Fiscal deficits increased substantially after the global financial crisis, and recent declines in commodity prices have further hurt fiscal revenues. Moreover, a long period of low global interest rates also facilitated an increase in corporate external debt, especially dollar denominated. These two features are now threatening local financial stability. Lessened or no existent fiscal space severely constraints the authorities’ capacity to support the economy. And highly indebted firms might face problems rolling-over existing liabilities in the, currently very volatile, international capital markets; this, in turn, would affect firms’ ability to make good on their loans from local banks.
The “Sound Banks for Healthy Economies in Latin America and the Caribbean” Working Group explored these and other key issues related to financial systems and developed specific recommendations for maintaining financial stability and ensuring that banks play a constructive role during and beyond the COVID-19 crisis. Led by co-chairs Andrew Powell and Liliana Rojas-Suarez, this working group was the result of a collaboration between CGD and the Inter-American Development Bank. The group was formed by international finance experts and Latin-American and the Caribbean policymakers and prepared a report to be launched on September 16, 2020. The recommendations for policymakers in the region are organized in five categories: i) Currency mismatches, corporate refinancing needs, and monetary and liquidity policies; ii) Fiscal transfers and budgeting; iii) Loan classification, moratoria, and restructuring; iv) Assisting viable firms: guarantees vs other instruments; and v) Exit rules for banks.