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Can International Capital Standards Strengthen Banks in Emerging Markets?

  • Liliana Rojas-Suarez

    (Institute for International Economics)

Who should determine banks' capital standards: authorities or markets? What is the right definition of core capital: equity only or equity plus subordinated debt? Can the assessment of banks' individual credit risks by external rating agencies be of equal or better quality than the assessments derived from banks' own internal rating systems? These are some of the key financial regulatory issues currently being discussed by analysts in industrial countries, especially in the context of the proposed modification to the Basel Capital Adequacy Accord: Basel II is expected to replace the original 1988 Accord. With a few exceptions, these issues are certainly not at the center of the debate in emerging market financial circles. There, the financial issues at hand depend on the country's level of development. For the least developed countries, reform agendas are just advancing in the implementation of accounting standards, disclosure, and other principles of bank supervision; Basel II is certainly not in the medium-term future. If anything, implementation of the original Accord is the issue. The more advanced emerging economies face a different dilemma. Albeit at very different paces, most of these countries embarked on a financial sector reform process in the early 1990s. One of the most important efforts by individual countries, also strongly supported by multilateral organizations, has been the adoption of the recommendations on capital adequacy requirements by the Basel Committee on Banking Supervision. However, in spite of significant advances in implementation, banking crises have abounded in emerging markets during the 1990s and early 2000s. Not surprisingly, some disillusion with a "traditional" reform agenda has emerged. A key debate, therefore, centers on assessing whether regulatory standards that work in industrial countries are appropriate for emerging markets. Among the most relevant issues are: (a) Can an early warning system of banking crisis particular to emerging markets be constructed? (b) How should capital adequacy ratios be designed in emerging markets? Should they diverge from the recommendations of Basel? And, (c) rather than focusing on "strengthening" banks, shouldn't emerging markets limit the role of banks, and instead, focus on the development of corporate bond markets? This paper deals with the appropriateness for emerging markets of implementing capital requirements as recommended by the Basel Committee on Banking Supervision. The paper is part of a research agenda that I initiated in the late-1990s. In my previous research I concluded that such capital standards have had very little usefulness as a supervisory tool in emerging markets. For fundamental reasons that go beyond the improvements in regulatory procedures, and, instead center on the particular features of financial sectors in many emerging economies, the capital-to-asset ratio has not been a useful early warning indicator of banking problems.

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Paper provided by Peterson Institute for International Economics in its series Working Paper Series with number WP01-10.

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Date of creation: Nov 2001
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Handle: RePEc:iie:wpaper:wp01-10
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  1. Michael Gavin & Ricardo Hausmann, 1996. "The Roots of Banking Crises: The Macroeconomic Context," Research Department Publications 4026, Inter-American Development Bank, Research Department.
  2. Reinhart, Carmen, 2002. "Sovereign Credit Ratings Before and After Financial Crises," MPRA Paper 7410, University Library of Munich, Germany.
  3. Powell, Andrew, 2002. "A capital accord for emerging economies?," Policy Research Working Paper Series 2808, The World Bank.
  4. Cavallo, Michele & Majnoni, Giovanni, 2001. "Do Banks provision for bad loans in good times? empirical evidence and policy implications," Policy Research Working Paper Series 2619, The World Bank.
  5. Liliana Rojas-Suarez, 2001. "Rating Banks in Emerging Markets: What Credit Rating Agencies Should Learn from Financial Indicators," Working Paper Series WP01-6, Peterson Institute for International Economics.
  6. Michael Gavin & Ricardo Hausmann, 1997. "Make or Buy? Approaches to Financial Market Integration," Research Department Publications 4052, Inter-American Development Bank, Research Department.
  7. Steven Riess Weisbrod & Liliana Rojas-Suárez, 1995. "Financial Fragilities in Latin America: The 1980s and 1990s," IMF Occasional Papers 132, International Monetary Fund.
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