The Argentine Banking Crisis of 2001 by Victor Malca
The economic problems of the late 1980s and the hyperinflation of 1989 and 1990 destroyed the Argentine financial system. However, macroeconomic stability returned with the imposition of the currency board and the significant opening and liberalization of the economy. Between 1992 and 1999, Argentina's banking system was liberalized by lifting controls, deregulating the banking sector, allowing the entry of foreign capital, and adopting international regulatory standards.
These changes were seen as the most radical attempts to strengthen a banking system in Latin America and the end of ineffective regulation and supervision in Argentina. Even when the Tequila crisis hit Argentina, the government continued the reform process and ensured market discipline by strengthening the regulatory framework through the BASIC system of banking regulation. Nevertheless, those changes were not enough to prevent the Argentine banking crisis of 2001.
The banking system had several vulnerabilities that were not revealed through CAMEL type bank fundamentals, but showed up as the government was trying to defend its currency board. Through those vulnerabilities, banks and depositors were adversely affected as fears of the currency board’ sustainability mounted. Depositors reacted by transferring larger and larger portions of their funds into foreign currency denominated accounts and banks continued increasing their exposure. In the end, the crisis led to a full-fledged run affecting all kinds of deposits. The result was the withdrawal of 6% of all bank deposits and the use of the ‘Corralito’ to contain the bank run.
The Argentine government also failed to sufficiently isolate the solvency of the banking system from the solvency of the government. According to De la Torre (2003), one silver lining of convertibility is that, in principle, it makes it possible to protect banking intermediation from the vagaries of the fiscal process, as long as banks are not significantly exposed to domestic government risk. This is possible because the dollar is the store of value that underpins financial intermediation in a currency board and does not depend directly on the solvency of the domestic government. Because the debt was denominated in dollars and financed through domestic banks, the banking system became considerably exposed to government default.
The liquidity safeguards for the banking system proved to be inadequate to protect the payment system during a depositor run. Reputable foreign banks did not provide enough capital or liquidity assistance to their subsidiaries as expected by the markets. In the absence of a credible lender of last resort, the payment system became vulnerable and finally collapsed. According to Hausmann (2002), the protection of a payment system from bank runs may actually require some form of narrow banking structure. Liquidity would be earmarked to these balances and thus able to preserve the functioning of the payment system.
These vulnerabilities were mutually reinforcing in such a way that left a seemingly strong banking system highly fragile. The real depreciation severely affected public finances since most of the government debt was denominated in dollars while public revenues were not. Moreover, the peg itself hid the impending solvency problems of public and private debtors as banks’ fundamentals seemed to be strong. Ultimately, these vulnerabilities left the banking system exposed to shocks and opened to a banking crisis that materialized in 2001.