2 The Argentine Banking Crisis of 1980

International Monetary Fund
Published Date:
March 1991
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Tomás J. T. Baliño1

I. Introduction and Overview of the Literature on Argentina’s Financial Crisis

In March 1980, one of the largest private banks in Argentina—Banco de Intercambio Regional (BIR)—failed; within a few days, the Central Bank had to intervene three other major banks, two of which were subsequently liquidated.2 Thus began a serious crisis of the Argentine financial system, which resulted in the liquidation of 71 financial institutions over the next two years and caused far-reaching changes not only in the financial system but also in economic policies. The restructuring process is still continuing. Most of the authors who have analyzed these developments have concentrated on the broad macroeconomic aspects; a few others have dealt with selected features of the Argentine financial sector in the context of the crisis. This chapter integrates these two sets of analyses and focuses more closely on the financial sector by emphasizing the regulatory aspects that previous studies have largely ignored.

This section provides a brief overview of selected literature on the Argentine financial crisis. The next section presents evidence on the macroeconomic and general business environment, and Section III analyzes the crisis itself. Section IV presents the conclusions. The research strategy followed in the paper reflects the belief that an appropriate analysis of the Argentine banking crisis has to look beyond the financial system, because a main cause of the crisis was the deterioration of the system’s loan portfolio—a deterioration that stemmed in part from developments in the general economic environment and their effects on business conditions.

Overview of the Literature

The Argentine financial crisis has been discussed mainly in the context of the economic policies implemented between 1977 and 1981, with only a few studies focusing on the financial system.3 This section briefly reviews the different approaches that have been followed in the literature. Fernández discusses three causes of financial crises: inadequacies of free market economies, inappropriate monetary policy, and inherent instability of the financial system.4 For him, the latter best explains Argentina’s financial crisis: under a fractional reserve system with state deposit insurance, financial institutions in trouble can delay failure by resorting to “liability administration.” Liability administration is described as the policy of an institution that, facing a cash shortfall caused by nonperforming loans, must raise interest rates to attract new deposits to replace those maturing. An explosive situation can result.

According to Fernández, this situation arose during the Argentine financial crisis as firms defaulted on their bank loans. These defaults were due to enterprise failures, which, in turn, were caused by frustrated expectations over macroeconomic policy and over the relationship between interest rates and the rate of change in the price of each enterprise’s product. Finally, Fernández finds merit in Simons’s proposal for financial reform, under which sight deposits would have a 100 percent reserve requirement to preserve their liquidity while time deposits would be replaced by bank acceptances or shares whose value would be market determined, that is, time deposits would resemble mutual fund shares.

Commenting on Fernández’s paper, Feldman (1983) suggests that the financial crisis should not be interpreted in isolation but should be viewed as a reflection of the real sector crisis that resulted from the growing incompatibility between real domestic interest rates and the rates of return of investments in domestic assets. Furthermore, Feldman suggests that high domestic interest rates largely reflected risk premiums owing to devaluation expectations that exceeded the Government’s preannounced, and realized, devaluation rates.

Using the framework developed by Minsky (1977), Dreizzen (1984) constructs several indicators to study the financial situation of a sample of industrial firms. He concludes that between 1977 and 1983 the financial structure of firms became increasingly fragile and had to endure strong destabilizing shocks, most of which originated in the financial market. Among the shocks that took place at different times in that period, he cites restrictive monetary policy, bank failures, and devaluations.

Another paper, by Petrei and Tybout (1985), examines firms’ indebtedness by analyzing a sample of industrial firms during the period 1976–81. They suggest that these firms originally obtained huge financial subsidies because of “real currency appreciation and unconstrained access to foreign credit, then again in 1981 because of an exchange insurance program.” Moreover, the accelerated growth in the debt/capital ratio in 1980, coinciding with lower profit rates for the firms in the sample, contributed to the development of the crisis.

Arnaudo and Conejero (1985) compare the performance of the three banks that failed in 1980 (Banco de Intercambio Regional, Banco de Los Andes, and Banco Internacional) with one another and with the average performance of private domestic banks. They conclude that several indicators warned of the impending failures of these three banks.

Damill and Frenkel (1987) further develop some of the points raised in the earlier literature. They suggest that the negative real rates of 1979 prompted firms to borrow more, thereby increasing their fragility. This fragility was exacerbated by the short maturities of loans, which made firms particularly vulnerable to “exogenous shocks,” such as higher interest rates induced by changes in exchange rate expectations. The consequent loss of profitability of some sectors increased the share of nonperforming loans in bank portfolios. Moreover, some banks that went bankrupt in 1980 had spectacular rates of growth, which the authors attribute to “speculative elements.”

The literature just reviewed suggests that the economic environment, as well as factors intrinsic to the financial system, led to the crisis in the Argentine financial system.

II. The Economic Environment

The 1976–82 period saw many economic changes in Argentina. The economic team that came to office in March 1976 inherited a high rate of inflation, a serious balance of payments problem, and a substantial fiscal deficit. The new team not only adopted short-term measures to cope with this situation but also carried out some important structural reforms, the most radical of which took place in the financial sector. Many of these measures and reforms were blamed for the serious difficulties that surfaced when the financial crisis erupted. As a result, beginning in March 1981, economic policy was significantly modified and most of the reforms begun in 1976 were scrapped.

Table 1.Phases of Reference Cycles, 1961–82


July 1963–May 196746Aug. 1961–July 196323
Dec. 1967–Dec. 197484May 1967–Dec. 19677
Nov. 1975–July 197720Dec. 1974–Nov. 197511
Mar. 1978–Feb. 198023July 1977–Mar. 19788
Feb. 1980–Jan. 198111
Jan. 1981–July 19816July 1981–Apr. 19829
Average length: 35.8 monthsAverage length: 11.5 months

To facilitate assessment of the contribution of changes in the economic background to the financial crisis, this section presents some evidence on the behavior of the economy between 1976 and 1982: (1) the evolution of GDP and its major components; (2) the evolution of monetary and credit aggregates; (3) the behavior of some important prices (interest rates, the exchange rate, and some asset prices); and (4) the evolution of enterprise debt.

Evolution of GDP and Its Major Components

Consideration of the evolution of GDP and its components is relevant for the analysis of the financial crisis on at least two grounds. First, a significant body of literature produced by Kindleberger, Minsky, and others asserts that financial crises are an integral part of the business cycle, because they are a necessary consequence of the previous boom. Second, a downturn in economic activity can reduce firms’ sales and profits in the affected sectors, compromising the liquidity and solvency of these firms and, therefore, their ability to service their debt.

Table 1, which presents the phases of reference cycles for Argentina from 1961 through 1982, shows that the financial crisis followed an economic expansion: the failure of the Banco de lntercambio Regional in March 1980 came immediately after the expansionary period that had lasted from March 1978 to February 1980.5

The national accounts data confirm that the financial crisis came after a period of economic expansion: although GDP fell by 3.4 percent in 1978, it grew at rates substantially above historical performance in 1977 and 1979; between 1976 and 1979 the growth rate averaged 3 percent. The crisis cannot be dated so easily with reference to investment, however, because investment kept growing at a rate much above historical averages even after the crisis started; only in 1981 did investment begin to fall sharply. Finally, there were sharp differences in the performance of many sectors; in particular, the financial sector grew much faster than total GDP between 1977 and 1980 but shrank sharply between 1981 and 1983. Moreover, in any given year, rates of growth varied substantially across sectors. These sharp fluctuations in performance undoubtedly required various economic sectors to make substantial adjustments, which may have affected their debt-servicing capacity.6

Behavior of Monetary and Credit Aggregates

Table 2 presents data on the behavior of monetary and credit aggregates in the 1976–82 period. These data are useful not only to complete the general background but also to analyze whether monetary factors could have caused the financial crisis.

The table presents the data in nominal terms, from which two main conclusions can be drawn: (1) that monetary and credit aggregates grew very fast throughout the period, and (2) that time deposits significantly increased their share in M2, jumping from 36 percent in 1976 to 71 percent in 1981.

The data in Table 2 suggest that the crisis cannot be attributed to monetary causes: money grew in nominal terms at a high rate both before and after the crisis, although the rates of growth of M1 and M2 fell sharply in 1980, once the crisis was under way. The data for domestic credit show a similar pattern.7

Further evidence on monetary developments is provided in Table 3, which presents data on the behavior of the ratios of currency/money and of excess reserves/liabilities subject to reserve requirements. According to the monetarist hypothesis, changes in these ratios caused monetary contractions in the United States that resulted in financial crises and recessions.8 This hypothesis implies that the rise in these ratios depressed the money multiplier, inducing a fall in the money supply or in its rate of growth.

Table 2.Main Monetary and Credit Aggregates, 1976–82

(In thousands of australes)1







End of YearAmountAmountincreaseAmountincreaseAmountincreaseAmountincreaseAmountincreaseAmountincrease
In nominal terms
Monetary aggregates
Demand deposits5210195.9230127.7596158.91.09383.41,58945.36,128285.7
Time and savings
Deposits of
public sector with
commercial banks38125229.1286127.8673135.61,413109.92,861102.58.253188.5
Credit aggregates
Domestic credit2189655246.21,829179.15,392194.811,268109.033,457196.9104,491212.3
Credit to
private sector3121433257.91,218181.04,002228.68,345108.522,197166.068,928210.5
Credit to
public sector268222225.4611175.31,389127.52,923110.411,260285.235,563215.8
Source: Central Bank of Argentina, Boletín Estadístico, various issues.

The austral is the currency unit introduced in Argentina in 1985 to replace the peso (

1 = $a 10 million).

Includes outstanding balance of “Cuenta de Regulación Monetaria’ (Interest Equalization Fund).

Includes loans in foreign currency.

Source: Central Bank of Argentina, Boletín Estadístico, various issues.

The austral is the currency unit introduced in Argentina in 1985 to replace the peso (

1 = $a 10 million).

Includes outstanding balance of “Cuenta de Regulación Monetaria’ (Interest Equalization Fund).

Includes loans in foreign currency.

Table 3.Ratios of Currency to Deposits and Excess of Bank Reserves to Reserve Liabilities, 1976–82


Excess Bank


Sources: Central Bank of Argentina, Boletín Estadístico, various issues; Gaba (1981); and International Monetary Fund, International Financial Statistics, various issues.

The series begins with the reintroduction of fractional bank reserves in June 1977.

Period average.

End-of-quarter data.

Sources: Central Bank of Argentina, Boletín Estadístico, various issues; Gaba (1981); and International Monetary Fund, International Financial Statistics, various issues.

The series begins with the reintroduction of fractional bank reserves in June 1977.

Period average.

End-of-quarter data.

The data do not support this hypothesis for the Argentine financial crisis. As shown in Table 3, the currency/deposit ratio was lower by the end of the first quarter of 1980 (when the Banco de Intercambio Regional was closed) than in the same period of the previous years; although this ratio tended to rise during the rest of 1980, it still remained below the levels of 1976 and 1977. This situation suggests that the crisis undermined the public’s confidence in the safety of deposits only briefly. A study of the period from June 1977 to June 1981 finds evidence of a shift in the intercept of the estimated function for the currency/deposit ratio (Demaestri (1982)). This shift was positive for April and May and negative for June 1980. Another study of the period from May 1978 to March 1982 (Dabos and Demaestri (1983)) found that the demand for currency, in real terms, became less sensitive to the deposit interest rate beginning in March 1980 (i.e., before the liquidation of the first major bank but after the liquidation of one of the largest financial companies).

The excess reserve ratio fluctuated widely between the end of the second quarter of 1977 (the start of the financial liberalization) and the end of 1982. Even after the outlier observations for the second quarter of 1977 and for the whole of 1982 are excluded, the ratio remained volatile: for instance, it dropped from 1.88 to 0.20 between the second and third quarters of 1978.9 Despite this volatility, the data for 1979 are well within the historical range of values, suggesting that bank reserve behavior was not a contractionary influence on the money supply.10 More important, the fact that the behavior of bank excess reserves in 1980 shows no departure from the historical pattern suggests that the crisis did not reduce the willingness of banks to invest in yield-earning assets.

The Behavior of Interest Rates

Several authors have blamed interest rate behavior during and after the liberalization experience for the business failures that occurred between 1977 and 1982. The purpose of this section is to present evidence that can help to evaluate the merits of that explanation.11

Nominal interest rates jumped dramatically when interest rate controls were lifted at the end of the first half of 1977: both deposit and lending rates more than doubled from the first to the second half of 1977. It is important to gauge the volatility of interest rates before the crisis, because a high volatility could frustrate business planning and undermine the financial health of firms. The monthly variability of interest rates within each year, measured by the coefficient of variation, was lower during 1979 and 1980 than at any other time between 1977 and 1982.12 This lower variability was probably caused by the policy of preannounced devaluations between December 1978 and March 1981, which encouraged interest rate arbitrage by reducing exchange rate risk.

The data in Table 4 show that annual average lending rates were positive in real terms during the liberalization period. Also, their highest value (4.87 percent a month, using the wholesale price index—WPI) was attained in the last quarter of 1979; moreover, the annual average of lending rates peaked in 1980. Therefore, high lending rates helped to precipitate and aggravate the crisis by making debt servicing more difficult. However, although these rates were positive on average, and sometimes very high, they were negative during many quarters. Thus the effect on each firm depended not only on the sign and size of its net financial position but also on the pattern of this position through time.

The behavior of real lending rates raises several issues. First, did the high loan rates reflect high deposit rates as well as high spreads? Second, why did enterprises not switch to foreign borrowing? Third, why were enterprises prepared to borrow at rates much higher than the marginal rate of return on investment?

Table 4 indicates that, although lending rates fluctuated in line with variations in deposit rates, the large and volatile spreads contributed significantly to the observed high lending rates. In order to explain the high spreads, Gaba (1981) broke them down into the cost of reserve requirements, the cost of excess reserves, and the gross financial yield for the bank (after taking into account the effect of non-interest-bearing deposits). He found that, except for the second half of 1977, when the high reserve requirement accounted for the largest share of the spread, by far the largest component was the gross financial yield required to cover administrative costs and profits.

Some studies have identified high administrative costs as a significant component of the spreads.13 Although these costs, shown in Table 5, are sizable, a large residual component of the spread remains to be explained. One explanation of the residual is that banks had some monopoly power, which they exploited by charging rates that included a monopoly rent. On the surface, this explanation is appealing: bank services are differentiated products that offer scope for imperfect competition (e.g., it is costly for borrowers to switch banks). A corollary of this explanation is that more competition should lower spreads. In this regard, the liberalization measures, which not only freed interest rates but also eliminated barriers to entry, should have undermined the monopolistic position of the banking system and thus lowered spreads. But it could be argued that whereas eliminating entry barriers reduced monopolistic rents, dismantling interest rate controls allowed banks to better exploit whatever monopoly power they retained. Thus the net effect of the 1977 reform on the rent component of spreads appears to be ambiguous. Another possible explanation is that high spreads reflected risk premiums on loans, which rose because of uncertainties about the course of economic policy and because banks knew very little about many of their new clients.14 This explanation helps to explain why borrowers were willing to pay high real rates,15 but it is inconsistent with the explanation that borrowers were willing to pay high rates because they expected a government bailout—because if bankers shared that expectation they would have viewed their loans as low-risk assets and hence charge a low-risk premium.16 A detailed analysis of the causes of high spreads is beyond the scope of this paper.17

Table 4.Real Interest Rates, 1974-82(In percent a month)
Deposit Rate

Deflated by1
Lending Rate

Deflated by1
1977 Average-1.86-1.42-0.610.01
1978 Average-1.450.510.060.99
1979 Average-0.93-0.56-0.240.13
1980 Average-0.411.110.481.99
1981 Average0.81-1.012.570.76
1982 Average-3.02-5.79-2.02-4.80
Source: Central Bank of Argentina.

The formula used for deflation was: Real rate = (nominal interest rate - rate of inflation)/ (1 + rate of inflation).

Corresponds through the first semester.

Source: Central Bank of Argentina.

The formula used for deflation was: Real rate = (nominal interest rate - rate of inflation)/ (1 + rate of inflation).

Corresponds through the first semester.

Table 5.Administrative Costs of Financial Institutions, 1981–821
Official national banks6.
Official state and municipal banks12.89.413.312.3
Domestically owned private
commercial banks7.
Foreign-owned private commercial banks9.
Investment banks13.48.513.013.5
Finance companies9.09.514.815.8
Credit cooperatives11.912.621.622.7
Savings and loan associations7.410.112.912.7
Weighted average28.
Sources: World Bank (1984), and author’s own estimates.

Administrative costs a year as percentage of total loans.

The weights used are the shares in total loans as of end-December 1982.

Sources: World Bank (1984), and author’s own estimates.

Administrative costs a year as percentage of total loans.

The weights used are the shares in total loans as of end-December 1982.

Although the high spreads made domestic loans appear more expensive than foreign loans, firms did not switch to foreign sources of credit, in part because the preannounced devaluation schedule (described in the next subsection) did not eliminate the uncertainty over the course of the exchange rate. In this regard, several authors18 have suggested that a perceived exchange risk discouraged foreign borrowing. This reasoning is consistent with the fact that the domestic deposit rate exceeded the yield in pesos of dollar deposits abroad until February 1981,19 thus indicating that borrowers and depositors shared similar expectations over the course of the exchange rate. Another reason is that probably only large enterprises had direct access to foreign credits (Petrei and Tybout (1985)). The evolution of interest rate differentials is depicted in Table 6, where the U.S. prime rate was taken as the representative rate for borrowers and the treasury bill rate as the representative rate for deposits. Analyzing a similar data set, Blejer (1982) concluded that the Argentine financial market was informationally efficient but that an uncorrelated time-varying risk premium was present between June 1977 and August 1981.

Several hypotheses have been offered to explain why firms borrowed at relatively high real interest rates. Besides the high-risk and bailout hypotheses already mentioned, the explanations include distress borrowing by firms in difficulties and speculative borrowing induced by devaluation expectations.20

Table 6.Differentials Between Domestic and Foreign Interest Rates, 1977–82(Quarter averages; in percent a month)
U.S. Rates1Interest Rate Differential


bill rate
With Argentine

lending rate
With Argentine

deposit rate
Sources: International Monetary Fund, International Financial Statistics, various issues; and Central Bank of Argentina.

Adjusted for the actual depreciation of Argentina’s currency.

Sources: International Monetary Fund, International Financial Statistics, various issues; and Central Bank of Argentina.

Adjusted for the actual depreciation of Argentina’s currency.

Liberalization of Foreign Sector

The policies followed in the external sector, especially exchange rate policies, had important effects on the soundness of the financial system, directly by influencing the capital flows and the value of the foreign debt of firms, and indirectly by dramatically changing many relative prices in the economy—in particular, asset prices.

The lackluster record in the fight against inflation prompted the authorities to use the exchange rate as a stabilization instrument, beginning in December 1978 and ending in March 1981.21 For this purpose the Central Bank periodically published a schedule of daily devaluations for given periods of time. This strategy was intended to make tradable prices follow international prices (nontradables would follow a similar path, assuming some substitutability between tradables and nontradables). Moreover, the preannouncement of the rate was expected to reduce uncertainty and to help make domestic interest rates move in line with foreign rates.

The first exchange rate schedule covered the period through August 31, 1979. Several others followed, carrying a declining rate of devaluation. On October 1, 1979 the third schedule was issued: it set a 2.8 percent devaluation for January 1980, to be reduced by 0.2 percentage point a month through the end of 1980. In September 1980, however, the authorities revised the schedule and announced that the devaluation rate that had been set for October (1 percent) would be maintained for November and December. This policy led to a substantial real appreciation of the peso, which began to affect the exchange market.22

After some failed attempts at restoring confidence in the exchange policy, a new economic team scrapped the policy of preannounced devaluations and sharply devalued the peso (by about 23 percent). In addition, the team stated that, in the future, they would follow a policy of frequent minidevaluations. Despite these statements, further reserve losses prompted a new devaluation of about 23 percent on June 2. Twenty days later, the foreign exchange market was split in two: a commercial market, with the rate to be set by the Central Bank, and a financial market, with the rate to be determined by the market.23 Transactions to be carried out in the latter market included most new financial transactions, sale of a specified fraction of the proceeds of some exports, and other transactions that were not allowed to be made through the commercial market. In order to reduce the effect of past devaluations on private foreign debt and to encourage renewal of foreign loans, the Government compensated borrowers for the effects of the June devaluation on loans that were rolled over for at least one year. To encourage further rollover of foreign debt, the Government also established an exchange insurance facility; to qualify, new loans or loan renewals had to have a minimum maturity of one and a half years. In the last quarter of 1981, the scope of the exchange insurance facility was broadened and a swap facility was established for six-month operations.

The administration that came to power in December 1981 returned to a more liberal exchange system, unifying the exchange markets, eliminating the exchange insurance and swap facilities, liberalizing sales of foreign currency, and announcing that the peso would be allowed to float. In April 1982, however, drastic exchange controls were imposed to cope with the problems caused by the conflict with Britain over the Falkland Islands/ Malvinas. Subsequently, a new administration, inaugurated in July 1982, reintroduced dual exchange markets, one commercial and the other financial. The Central Bank set the rate in the first market, but in the second it intervened solely as a buyer, at a predetermined rate. Gradually, however, operations initially assigned to the commercial market were transferred to the financial market, and in November both markets were merged.

These policies substantially affected the real effective exchange rate, as depicted in Table 7. These data show a real appreciation of the domestic currency of about 31 percent (export-weighted index) or 35 percent (import-weighted index) between December 1977 and March 1980 (when the financial crisis surfaced). This appreciation continued until the end of 1980 to a cumulative total of 40.5 percent (export-weighted index) or 42.5 percent (import-weighted index); in January 1981, the effective exchange rate began to fall as a result of the faster devaluation of the peso, a process that continued for the rest of the period covered in Table 7.

The uncertainty introduced by shifts in exchange rate policy was compounded by the changes in the degree of openness of the economy to capital and trade flows. Between 1976 and 1982, the openness of the economy to capital flows changed several times. The first period, from April 1976 to March 1981, was characterized by a dismantling of restrictions and a higher degree of integration of the domestic and international financial markets. The problems that surfaced in 1981 and 1982 in the foreign sector increased the risk of foreign borrowing for both borrowers and lenders and reduced that integration; this reduction was aggravated by the increased exchange rate volatility already mentioned, by the dwindling reserves, and by the measures taken in 1982 to restrict debt repayments.

The liberalization of capital flows was coupled with liberalization of trade between 1976 and 1981, but the trade liberalization was never so comprehensive as financial liberalization. Two main pieces of trade liberalization were a program of phased tariff reductions to be carried out between 1979 and 1984 and the elimination of import prohibitions. However, the newly inaugurated administration abandoned the tariff reduction program on April 1, 1981.

Table 7.Evolution of the Exchange Rate, 1977–82
Real Exchange Rate Indices1
Exchange Rate

(australes per US$100,

period average)
Export weighted

(Dec. 1969 = 100)
Import weighted

(Dec. 1969 = 100)
Source: Central Bank of Argentina.

Based on monthly averages of the nominal exchange rate adjusted by price (WPI) and exchange rate movements in Argentina’s major trading partners.

From June 22, 1981 to December 24, 1981 and from July 5, 1982 to November 1, 1982 the foreign exchange market was split into a commercial and a financial market. For effective exchange rate calculations, the rate actually applicable to trade transactions (i.e., commercial or mixed rate) was used.

Source: Central Bank of Argentina.

Based on monthly averages of the nominal exchange rate adjusted by price (WPI) and exchange rate movements in Argentina’s major trading partners.

From June 22, 1981 to December 24, 1981 and from July 5, 1982 to November 1, 1982 the foreign exchange market was split into a commercial and a financial market. For effective exchange rate calculations, the rate actually applicable to trade transactions (i.e., commercial or mixed rate) was used.

Wage Policy

The wage policy followed during much of the liberalization period aimed at adjusting salaries more or less in line with inflation, as measured by the consumer price index. This policy, combined with the exchange rate regime just described, dramatically increased real labor costs, particularly in dollar terms: real wages in terms of dollars increased by almost 177 percent between December 1978 and December 1980,24 while real wages in terms of the CPI and the WPI increased by only 23 and 54 percent, respectively.25,26 The result was a loss of competitiveness of Argentine tradable goods, which deteriorated the foreign sector position and the economic solvency of producers of those goods.

Changes in Asset Prices

The purpose of this section is to investigate whether a speculative bubble could have played a role in the crisis.27 A speculative bubble that drove up asset prices could have induced people to borrow in order to purchase those assets. When the bubble burst, the price of assets would suddenly have become lower than the value of the counterpart loans.28 This situation would have made borrowers unable—and unwilling—to repay their debts, while banks would have found that foreclosing did not allow them to recover their credits in full.

Table 8 presents the prices of some assets deflated by the wholesale price index (WPI) and by the peso/dollar exchange rate. These deflators are particularly useful because of the existence at the time of substantial public holdings of financial assets and liabilities linked to the WPI or the U.S. dollar. Thus, the ratios in Table 8 also illustrate the opportunity cost of holding real assets relative to holding such financial assets (or liabilities). The first two columns, which correspond to the price of cars, illustrate the effect of the appreciation of the peso over much of the liberalization period (as well as the restrictions on car imports). Whereas cars appreciated by only 18 percent vis-à-vis the wholesale price index between the second quarter of 1977 and the first quarter of 1980, they appreciated by almost 170 percent vis-à-vis the U.S. dollar over the same period. Furthermore, in this period the rate of appreciation vis-à-vis the WPI was negative in several quarters, whereas the appreciation vis-à-vis the dollar was continuous except for two quarters (last quarter of 1977 and second quarter of 1979). The appreciation vis-à-vis the dollar extended until the end of 1980, just before the policy of preannounced devaluation began to change in February 1981.

Table 8.Selected Relative Prices of Assets, 1977–84
Car Prices

Deflated by
Apartment Prices

Deflated by
Cattle Prices

Deflated by



Source: Central Bank of Argentina.
Source: Central Bank of Argentina.

Apartments appreciated steadily both with respect to wholesale prices and to the dollar (third and fourth columns of Table 8): between the second quarter of 1977 and the first quarter of 1980 apartments appreciated by 34 percent vis-à-vis wholesale prices and by 207 percent vis-à-vis the dollar; by the end of 1980 these rates of appreciation had reached 46 percent and 307 percent.29 The last two columns correspond to cattle prices.30 Again, although cattle appreciated by about 20 percent vis-à-vis wholesale prices between the second quarter of 1977 and the first quarter of 1980, its appreciation vis-à-vis the dollar was much higher—175 percent over the same period.

In summary, Table 8 suggests that no general pattern was evident for asset prices until the second quarter of 1981, when the substantial devaluations of the peso that had taken place during that quarter caused asset prices to plummet in terms of dollars; the dollar prices of assets remained substantially below the 1979–80 values throughout the period under analysis. Apartments depreciated both in terms of dollars and of the wholesale price index: the latter fall began in the first quarter of 1981, and the real price of apartments never returned to the high levels of the period that began in the second quarter of 1979 and ended in the first quarter of 1981.

Table 9 presents series on the index of value of the stock market. This index reflects the value of the outstanding shares of all firms listed in the Buenos Aires Stock Exchange valued at the latest available price. The first column shows the average value of the index over each month; the other two columns present the deflated values using the wholesale price index (second column) and the exchange rate index (third column). The series displays a high degree of variability;31 nevertheless, the index appreciated, both in terms of the wholesale price index and of the dollar, between the last quarter of 197732 and the first quarter of 1980—which is the peak period of the two series. The behavior of the stock value index differs sharply from the behavior of the relative price of the other assets just discussed. Stock prices dropped in both nominal and relative terms (compared with wholesale prices and the U.S. dollar) immediately after the start of the financial crisis (March 1980); in contrast, the dollar price of the assets included in Table 8 continued to increase while their price relative to wholesale prices showed no significant change in the next few quarters after that date.

Table 9.Stock Market Behavior(Base: January 1978 = 1)
Index of Stock Value

Deflated by

Deflated by

exchange rate
Sources: FIEL, Indicadores de Coyuntura, various issues; and Bolsa de Comercio de Buenos Aires, Boletln, various issues.
Sources: FIEL, Indicadores de Coyuntura, various issues; and Bolsa de Comercio de Buenos Aires, Boletln, various issues.

The evidence in Tables 8 and 9 does not support the hypothesis that a bursting speculative bubble caused the first episodes of the crisis (i.e., the bank failure and interventions of March-April 1980). However, the value of enterprises declined dramatically after the crisis began, partly as a result of the uncertainty induced by the crisis. This decline deepened the financial crisis by reducing the value of collateral and making it more difficult for enterprises to substitute capital market financing for banking loans.

The Combined Effect of Changes in Interest Rates and Relative Prices

The variability of interest rates and relative prices, including the prices of assets, complicates the analysis of the effects of lending interest rates on various sectors during the liberalization period. Gauging these effects helps in evaluating the merit of some demands for debt relief, which were based on the assertion that extended periods of high interest rates had driven many borrowers into insolvency. A way to analyze this issue is to compute the cumulative effect of real lending rates on a loan, using different price indices. This is done in Table 10 for selected prices. Figures in that table correspond to the ratio between the value of a loan33,34 and the price index indicated at the top of each column. Therefore, if a ratio rises between two dates, the debt burden of the borrower rises, measured as the units of the price index that would be needed to repay the loan. Alternatively, in the case of an asset, the rise in the ratio indicates what yield of the asset, compounded and net of depreciation, would have allowed borrowers to keep their wealth unchanged between the chosen dates.

The data in Table 10 show substantial volatility in most of the series: in particular, this is so when wages and cattle prices are chosen as denominators (first and sixth columns). The data also indicate that the debt burden, measured by the wholesale price index or by the stock price index, had begun to increase about two quarters before the first episodes of the crisis and continued to do so until the end of the first quarter of 1982. The next quarter the debt burden began to fall because of a rise in stock prices and a fall in real interest rates (the latter resulted from the establishment of interest rate ceilings in July 1982). For the same reasons, the debt burden measured in dollars also went down dramatically after the first quarter of 1982, using the exchange rate as the denominator (column 3).35

Enterprise Debt

The previous discussion suggests that economic agents had to face important shocks during the financial liberalization, which included significant changes in key relative prices—including assets—and, during some periods, high borrowing costs. The vulnerability of firms to such shocks depends, inter alia, on the ratio of debt to total assets (“gearing ratio”); a high ratio not only magnifies the effect of interest rates on firm profits but also indicates that the firm has a low capital base to absorb losses.

Petrei and Tybout (1984) have analyzed the evolution of the gearing ratio and similar indicators between 1976 and 1981. Their analysis is based on financial statements of 155 publicly traded industrial corporations, classified into three major categories: exportable goods producers, importable goods producers, and nontradable goods producers. Their work suggests that, except for exportables, the gearing ratio increased over the liberalization period, whereas liquidity fell and foreign debt increased as a proportion of total assets. They conclude:

During the late 1970s, firms appear to have substituted dollar debt for peso debt, keeping their overall leverage stable. But beginning in 1980, when earning rates fell sharply, firms steadily increased their reliance on debt finance. So this year and thereafter, some of the increase in firms’ financial riskiness may have been due to distress borrowing. The beginning of the upward leverage trend corresponds to the emergence of banking sector crises, and may well have been a causal factor, (p. 50)

Table 10.Real Interest Rates for Selected Price Indices, 1977–84(Base: January 1978 = 1)
Deflator Index1



Sources: Raw data provided by the Central Bank of Argentina and author’s own estimates.

Value of loan deflated by different price indices. The loan takes a nominal value of one in January 1978 and its quarter-to-quarter variations are due to accumulated interest (at the average market lending rate). Nominal values of the loan are deflated by the price indices indicated in the table.

Sources: Raw data provided by the Central Bank of Argentina and author’s own estimates.

Value of loan deflated by different price indices. The loan takes a nominal value of one in January 1978 and its quarter-to-quarter variations are due to accumulated interest (at the average market lending rate). Nominal values of the loan are deflated by the price indices indicated in the table.

Using the same data base, Dreizzen (1984) constructed an indicator of financial fragility f, based on Minsky’s theories. This indicator is defined as the ratio of debt-service payments to self-generated funds where debt service is defined as debt amortization plus interest payments, and self-generated funds are defined as profits plus asset depreciation and interest, minus taxes. Dreizzen’s sample included 143 “normal” enterprises and 23 that had to renegotiate their debts under judicial surveillance. Therefore it is possible to compare the behavior of these two categories of enterprises. His data suggest that the firms that eventually fell under judicial surveillance had a much higher increase in the index of fragility than normal firms. However, it is unclear whether this index provides an explanation of why some firms had difficulties or whether it just states those difficulties—that is, being unable to service debts with their own resources.

Business Failures

The economic developments just summarized caused business failures, which in turn contributed to the failure of banks and other financial institutions. Table 11 presents some data on the liabilities of failed business firms for the Buenos Aires court district. The table shows quarterly total liabilities in nominal terms (first column), deflated by the wholesale price index (second column), and as a ratio to bank credit to the private sector (third column). Inflation makes it difficult to interpret the first column. However, the last two columns give the same broad picture: business failures increased in real terms every year until 1982, peaking in the first quarter of that year, while the ratio of business failures to total private credit shows the same pattern, except for 1980 when the ratio fell.36 Moreover, the highest real rate of increaseof business failures (76 percent) was in 1980 (i.e., when the financial crisis started), although this development is masked in column 3 by the expansive credit policy followed vis-à-vis the private sector. Industry was the sector most seriously hit in the early stages of the crisis: its share in total liabilities of bankrupt firms jumped from 53.7 percent in 1979 to 83.9 percent in 1980.37

Table 11.Total Liabilities of Bankrupt Firms
Liabilities of Firms Declared Bankrupt over the Quarter1
In nominal termsDeflated by WPIDeflated by bank credit

to private sector
(In australes)
Sources: FIEL, Indicadores de Coyuntura, various issues; and International Monetary Fund, International Financial Statistics, various issues.

Comprises data for firms filing for bankruptcy or for judicial surveillance in Buenos Aires courts in each quarter.

Sources: FIEL, Indicadores de Coyuntura, various issues; and International Monetary Fund, International Financial Statistics, various issues.

Comprises data for firms filing for bankruptcy or for judicial surveillance in Buenos Aires courts in each quarter.

III. The Financial Crisis

The Financial System Before the Crisis

Argentina’s financial crisis was the result of the economic developments discussed in the previous section and of developments within the financial sector itself. A key aspect of the latter was the financial liberalization that was implemented in 1977, which drastically changed the functioning of the financial system. The delay in fully adapting the supervisory apparatus to these changes played a major role in deepening the crisis. Once the crisis started, the Central Bank acted swiftly to prevent the collapse of the financial system. However, the measures adopted over time to deal with the crisis had a long-term influence on the structure of the financial system and on the economy as a whole.

The Argentine financial system underwent radical changes in the 1970s. Before 1977, it was heavily regulated. This regulation had been reinforced by the law of nationalization of deposits enacted in 1973 and by the ensuing complementary measures adopted by the Central Bank. The nationalization law had established that commercial banks would receive deposits only for the account and on behalf of the Central Bank; the banks had to keep these deposits in the form of cash-in-vault or deposits with the Central Bank. In other words, banks had a reserve requirement of 100 percent.38,39 Banks could only lend out their own capital and reserves and the funds received via rediscount. The aim of that law was to empower the Central Bank to allocate credit selectively to different sectors and regions. The Bank also set the interest rates on loans and deposits.40 However, the system of nationalized deposits and regulated interest rates soon proved to be too rigid, particularly when the inflation rate, which had been repressed by price controls in 1973, went up significantly in 1974 and jumped dramatically in 1975. In addition, the lack of an explicit link between deposits and loans reduced bank incentives to attract deposits. Therefore the system had to be made more flexible. In 1975, interest rates on certificates of deposit were freed, and automatic rediscount facilities, linked to the growth of specified deposits, were introduced; interest rates on time deposits were also raised significantly. Despite these measures, the yield on nonindexed financial assets was negative in real terms. As a result, over the nationalization period (1973-77), M2 fell by 50 percent in real terms, time deposits by 56 percent, and Ml by 46 percent. This shrinkage of the financial system was made easier by the existence of indexed government bonds, which not only provided a hedge against inflation but also were very liquid.41

Entry into the financial system also was heavily regulated. The Central Bank had to approve the establishment of new banks and the opening and closing of branches of existing banks.42,43 The approval process included an evaluation of the need for new banking services and the prospective bank’s capital adequacy.

The administration that came to power in March 1976 immediately decided that a profound reform of the financial system was needed. The economic program announced on April 2, 1976 stated the need “to give back to the financial and banking system its flexibility and efficiency [by] eliminating the system of deposit nationalization that is inoperative from the point of view of official credit control and that also conspires against the development and agility of financial activity.”44 The reform legislation was enacted in early 1977; its two main pieces were Law 21495, which authorized the Central Bank to convert the financial system back to a system of fractional reserve requirements, and Law 21526, which provided a new legal framework for financial institutions.45

These laws provided the legal basis that allowed the Central Bank to deregulate the Argentine financial system to an unprecedented degree. The Central Bank freed interest rates, which had been totally or partially regulated since 1935. At the same time, in order to facilitate competition by improving market transparency, the Central Bank enjoined banks from charging commissions and special fees on loans, practices that had been widely used to raise the cost of credit when rates were regulated. The Central Bank also abandoned most selective credit practices, returning the responsibility for credit allocation to the commercial banking system; however, the Bank established a special refinance line to facilitate export financing at preferential rates.

Prudential Regulations and Bank Supervision Before the Crisis

Adapting prudential regulations and bank supervision to the new, more liberal, system created by the financial reform was difficult because the many years of heavy regulation provided no guidance on how the Argentine financial system would function in a more liberal environment.

The Central Bank of Argentina has traditionally enjoyed wide powers over the regulation and supervision of banks and other financial institutions. Such powers were preserved by the financial reform, thus allowing the Central Bank to revise existing regulations. The revised regulations covered four areas: capital requirements, asset immobilization, liabilities/ capital ratios, and ratios between the amount of the loan and capital (of the lender and of the borrower).

Minimum capital requirements varied according to the type and location of financial institutions. These requirements were adjusted annually by the wholesale price index.

The regulations on asset immobilization required that immobilized assets could not exceed 100 percent of the capital and reserves of financial institutions.46 For this purpose, immobilized assets were defined as physical assets, prepaid expenses, all kinds of noncurrent and value-impaired loans, and some other assets of lesser importance. In addition, noncurrent and value-impaired loans could not exceed 5 percent of the capital and reserves of financial institutions.

For all financial institutions, the maximum ratio of financial liabilities to net capital and reserves was set at 25. Limits were also set on the maximum financing, including both loans and bank guarantees, that a given client could obtain. These limits were set at 50 percent of the borrower’s capital and reserves for borrowing from any individual financial institution and at 80 percent for total borrowing from the financial system. Financial institutions could exceed these limits when clients offered real assets as collateral; moreover, loans to promote exports, some loans to state suppliers, and seasonal loans were not included in these ceilings. In addition, total financing to an individual client could not exceed 40 percent of the lender’s equity, and a sublimit of 30 percent was set for actual financing of any kind (i.e., excluding guarantees). There were some exceptions for these limits in the case of foreign trade operations.

At the same time, branching regulations were eased. The new law eliminated the requirement that the Central Bank had to approve branch openings of domestic banks. Thereafter, domestic financial institutions simply had to comply with some specific requirements and advise the Central Bank in advance of their intention to open a new branch. But, the Central Bank specified that institutions located outside the major centers would temporarily receive preference for opening branches.47 Local branches of foreign banks remained subject to prior authorization. Moreover, the establishment of new institutions and the transformation of existing ones were facilitated; many formerly nonbank institutions became banks, and thus could broaden the scope of their activities.

These regulations were revised over the years of the reform. Most of the revisions in 1978 and 1979 aimed at increasing the freedom of financial institutions. For instance, in 1978 the Central Bank eliminated the limit on maximum bank lending defined as a proportion of the borrower’s capital, but the limit defined as a proportion of the lender’s capital remained in force.48 In 1979 however, the Central Bank increased the minimum capital requirement for financial institutions, measured in real terms.49

An important change in deposit insurance took place in 1979. Until then, the Central Bank had fully insured depositors and had borne the full cost of the insurance scheme. The scheme that became effective in November 1979 provided limited coverage, and financial institutions were free to join or not. Those that decided to join had to pay a monthly fee equal to 3/10,000 of their average liabilities subject to reserve requirements. The scheme was not a funded insurance system, however, because the coverage provided was independent of the insurance fees collected. Domestic currency deposits of up to 1 million pesos50 were fully insured, whereas those above that amount would be insured only up to 90 percent; the amount that received full insurance would be adjusted monthly with the WPI. Deposits in foreign currencies were not insured.

These measures dramatically changed the perceived riskiness of financial assets, although the perception of risk became widespread only when failures of large institutions began. The public believed that one particular group of institutions provided de facto full insurance, despite the fact that most of them chose not to participate in the Central Bank insurance scheme. This group comprised state banks, usually guaranteed by the corresponding government (national, provincial, or municipal), and branches of foreign banks, which people thought would receive help from their parent banks in case of need. The riskiness of the rest of the system remained to be evaluated by the public, usually on the basis of scant information.

All in all, the prudential regulations in place at the time were fairly comprehensive. Moreover, lack of observance of central bank regulations carried penalties ranging from fines to withdrawal of the charter. However, the Central Bank lacked the supervisory structure to cope with a financial system that was growing fast and was experiencing a dramatic increase in its freedom of action. In addition, the liberalization of the system generated many mergers, transformations of one type of financial institution into another, and an expansion in the number of branches. Many new participants entered the financial system. Moreover, the Central Bank’s supervisory mechanism was biased toward monitoring compliance with regulations rather than analyzing the quality of bank assets—and poor quality assets would become an important cause of failures.

The Central Bank recognized these difficulties and started to study ways to improve its supervision of banks and nonbank financial institutions.51 However, a new comprehensive system of bank supervision became operative only as of January 1, 1981, well after the crisis had begun.52 In the meantime, the Central Bank supervised financial institutions through an analysis of the reports that those institutions had to submit periodically and through on-site inspections. It is hard to evaluate the quality and scope of this supervision, but the annual reports of the Central Bank usually provide some data on the number of inspections carried out over the year. Although the data are fragmentary, they suggest a drop in the percentage of institutions inspected between 1977 and 1981, which began to be reversed only in 1982.

The foregoing discussion suggests that the main supervisory problems were the lack of an appropriate supervisory mechanism and the scant use of the one available, rather than the lack of regulations or supervisory power, which were quite comprehensive. The Central Bank began to work on the first problem soon after the start of the reform, but it began to revamp the supervisory mechanism only in 1981, well after the crisis had begun.

Early Warning Indicators

The question arises as to whether the Central Bank, using available information, could have detected that a crisis was imminent. A way to answer this question is to construct some indicators and test their power in predicting the crisis; this was done in two papers on the Argentine crisis. The first, by Dueñas and Feldman (1980), presents a set of six indicators based on the financial statements (balance sheet and profit and loss statement) that banks have to file with the Central Bank of Argentina: (1) liquid assets/deposits; (2) capital, reserves, and nondistributed profits/risk-bearing assets; (3) problem loans/total loans; (4) risk-bearing assets/income-earning assets; (5) total operating costs/ total operating income; and (6) net income from exchange operations/total net income. The data sample runs from June 1977 to June 1979 and comprises 17 banks, 2 of which were later liquidated by the Central Bank. The study shows that those indicators would have provided early warning about the problems of those 2 banks. Only in January 1981, however, did the Central Bank begin to compute and use such indicators systematically—even though the necessary data had been available for a long time.

The second paper, by Arnaudo and Conejero (1985), also concludes that individual bank failures could have been predicted. Relying only on published sources, the authors considered several indicators to analyze the behavior of the four major banks that collapsed in March-April 1980. Their approach was to compare these banks with one another and with the average behavior of private domestic banks. Several indicators are discussed, including the “unit defensive position,”53 growth of deposits in relation to interest rate premium paid, cost per unit of deposits, share of foreign exchange operations, and branch expansion. Of these, the first three were effective in warning of the impending collapse. These two studies suggest that some indicators could have predicted the onset of the crisis. Other information regularly received by the Central Bank—such as bank reserve positions—could have provided additional warning of individual problem banks.

The studies just described suggest methods for detecting when individual banks depart from the system’s norm for some performance ratios. Although the Argentine crisis initially affected only a few banks, it became evident fairly soon that most of the system had substantial portfolio problems. Therefore, it is useful to analyze whether there were some leading indicators of the condition of the whole banking system.

Table 12.Share of Problem Bank Loans by Economic Sector, 1974–80(In percent)
Share of Problem Loans at End of Period1
Economic Sector1974197519761977197819791980
Primary sector1.711.700.352.152.733.5211.71
Electricity, gas,
and water0.021.080.470.020.370.170.33
Source: Central Bank of Argentina, Boletín Estadístico, various issues.

Includes all loans currently overdue for more than 10 days, and those that were overdue for more than 10 days in the past and for which special agreements were reached to regularize payments.

Excludes personal loans and loans to unclassified activities.

Source: Central Bank of Argentina, Boletín Estadístico, various issues.

Includes all loans currently overdue for more than 10 days, and those that were overdue for more than 10 days in the past and for which special agreements were reached to regularize payments.

Excludes personal loans and loans to unclassified activities.

Table 12 presents data on problem loans, as reported by banks to the Central Bank between 1974 and 1980. In the case of loans to the primary sector and manufacturing, the share of problem loans increased continuously beginning in 1976; the heavy weight of those two sectors in total loans then caused a similar increase in the overall ratio. But the other sectors do not show such a clear pattern until 1980, when every sectoral ratio increased dramatically and the overall ratio jumped by almost 250 percent. These data suggest that until the end of 1979 the deterioration of the portfolio of the banking system as a whole was not particularly alarming, especially given the structural changes that were taking place in the economy. But in 1980 that deterioration became alarming because the economy decelerated (Table 1 suggests that a recession began in February of that year). Moreover, indicators of the firms’ situation, such as earnings, liquidity, and profits, worsened.54 This worsening is also reflected in the jump in enterprise bankruptcies in 1980 (Table 11).

The Crisis

Although many of the problems that led to the financial crisis had been discussed for some time, until 1980 the evolution of the financial system had suffered no major setbacks. The first overt signs of a financial crisis were the failure of one bank, the Banco Intercambio Regional, on March 28, 1980; the intervention of three others by the Central Bank almost immediately afterward;55 and a significant reshuffling of deposits within the financial system. The failed bank had, in a few years, become one of the largest private banks in the country, with a network that had increased from 46 branches in 1977 to 96 in 1979. Its failure caused important losses to its depositors: those that had dollar deposits lost everything56 and those that had peso deposits lost the fraction uncovered by deposit insurance (at least 10 percent) plus the cost of having the insured fraction immobilized until the Central Bank actually paid off insured deposits.57 This failure made the public acutely aware of the fact that bank deposits had some risk, which varied widely from one institution to another. People withdrew funds from institutions whose solvency they questioned and deposited the funds with institutions the depositor considered solvent. In addition, operators in the interbank money market became more cautious because participants would have little chance of recovering loans made to a failed financial institution. Among the institutions whose solvency was questionable were those that had expanded enormously in a short time, largely because they paid high interest rates on deposits—in other words, institutions whose performance resembled that of the Banco de Intercambio Regional. The institutions that were considered solvent were those backed by the Government at any level (national, state, or municipal) or by a foreign parent institution, or, to a lesser extent, those domestic private banks that had a well-established reputation. Deposits could be reshuffled rapidly owing to their short maturities—time deposits were concentrated in maturities no longer than 30 days. This reshuffling and the drying up of interbank funds helped to propagate the crisis: The Central Bank had to intervene three banks within a month of the Banco de Intercambio Regional’s failure. Although the economic situation of these banks might have required some central bank action, the run on their deposits made urgent intervention the only policy option open to the Bank.

The Authorities’ Reaction to the Crisis

The authorities had to act on several fronts to cope with the crisis. First, they had to take emergency measures to avoid a bank panic; second, they had to search for longer-term solutions to the private debt problem and its effects on financial institutions; and third, they had to find ways to restructure the financial system.

Emergency Measures. When the Banco de Intercambio Regional was closed, the Central Bank had to address the solvency problem of those institutions that faced massive deposit withdrawals. Its first measure was to create a new credit facility to aid financial institutions whose deposits were falling. This step was taken on April 3, 1980, when it became evident that existing lender-of-last-resort facilities were inadequate to cope with the size of the withdrawals. The second measure was to increase by a multiple of 100 the maximum size of fully insured deposits retroactively to November 18, 1979, which was the date when the reduction in deposit insurance had come into effect.58 The third measure was the authorities’ intervention, on April 28, 1980, of the three banks that had suffered the biggest drain in deposits (Banco Internacional, Banco Oddone, and Banco de los Andes).

These measures gradually succeeded in stabilizing the situation. Aggregate deposits fell in real terms immediately after the start of the crisis, but by August they had already exceeded the March levels. However, the distribution of deposits among financial institutions changed in favor of state and foreign institutions, a pattern that persisted over time (Table 13).

Solutions to the Private Debt Problem. Once the immediate danger of a panic had been averted, the authorities turned their attention to the problem of private debt.59 The first actions attempted to provide relief by encouraging the lengthening of loan maturities, most of which had been very short (i.e., below one year). In November 1980, the Central Bank announced that it would be prepared to make advances to financial institutions at a much longer term (one year) than prevailing deposit maturities. By reducing the maturity risk of financial institutions, these loans would encourage those institutions to extend the maturities of their own loans. However, this measure was in operation only in November and December 1980. A second effort was made in April 1981 when a new scheme of central bank advances to financial institutions was announced. Financial institutions were allocated funds, first by auction and later by direct allocation, up to 12 percent of their deposits, at market-related rates. These funds had to be used to refinance existing business debt—mainly debts of the agricultural, manufacturing, and construction sectors. This scheme was abandoned in November 1981, when a special law established a more ambitious refinance program with the following characteristics:

  • (a) Banks and other financial intermediaries should refinance 50 percent of the liabilities of the manufacturing sector and 40 percent of the debt of other industrial sectors (excluding personal and mortgage debts) outstanding at the end of August 1981. The refinanced portion of the debt would be payable over seven years, with a three-year grace period. Borrowers would pay a yearly interest of 3 percent, and the principal would be fully indexed to the Financial Adjustment Index (Indice de Ajuste Financiero—IAF), which was computed by annualizing the interest rate paid by a sample of banks on 30-day deposits (tasa testigo).
  • (b)Banks and other financial intermediaries were authorized to rediscount with the Central Bank the full amount of the refinanced debt. This rediscount carried a zero rate of interest and was fully indexed to the IAF.
  • (c)Along with the rediscount, the banks had to lodge with the Central Bank a government bond for an amount equivalent to the rediscount. This bond had a maturity of seven years with a three-year grace period, was not transferable or negotiable (except between banks), and paid a yearly interest rate of 6 percent (tax free), with full indexation of the principal to the IAF.
  • (d)Private financial institutions were free to participate or not in the scheme. Participating institutions had to provide refinancing to all client firms requesting debt consolidation. Participation was compulsory for all official banks.
  • (e)Participating private institutions had the option to contribute 1.5 percent of the amount refinanced to a guarantee fund administered by the Central Bank. The guarantee fund applied to 75 percent of the refinanced debt, and provided banks with protection against bankruptcy or default by firms receiving refinance. If a firm defaulted, the guaranteed portion of the principal would be frozen, interest free (although it would continue to be indexed to the IAF), for the remainder of the seven-year period, at the end of which the guarantee would be made effective. The rediscount of that transaction and the equivalent bond amount would be canceled.
  • (f)Firms benefiting from the debt consolidation would have to increase their capital by 10 percent of the refinanced amount (IAF-adjusted) over a two-year period. Any distribution of dividends, moreover, would have to be matched by an equivalent cancellation of the (indexed) refinanced debt at the moment the distribution took effect. By March 1, 1982, this refinancing program had provided funds for 4,709 billion pesos—equivalent to about 2 percent of total loans to the private sector.
Table 13.Distribution of Deposits Among Groups of Institutions at Selected Dates, 1980–84(In percent)
End of PeriodState BanksForeign BanksAll Other Financial

March 198035.78.655.7
April 198040.910.248.9
May 198043.610.645.8
June 198042.710.446.9
September 198138.912.248.9
June 198240.012.747.3
June 198348.012.040.0
March 198444.715.140.2
Source: Central Bank of Argentina, Boletin Estadistico, various issues.
Source: Central Bank of Argentina, Boletin Estadistico, various issues.

The mechanisms just outlined were, in essence, refinancing schemes with an element of subsidy, but they still preserved the principle of free rates. Near the end of 1981 the authorities diluted this principle by setting a so-called reference rate and establishing that any interest differential over that rate had to be deposited with the Central Bank. This measure did not have much effect because the reference rate was rapidly phased out when the administration changed soon thereafter. This administration—in office between December 1981 and July 1982—restored free interest rates and tried to follow a free-market approach to economic management. However, the conflict over the Falklands/ Malvinas caused the authorities to intervene more actively in the economy—though not in the financial market—and eventually led to the downfall of the administration.

The administration that came to power in July 1982 believed that “there is a manifest disproportion between the magnitude of enterprise and household liabilities, both in pesos and dollars, and also the liabilities of the public sector itself, in relation to the value of real assets, especially productive assets (farm land, urban industrial, and commercial real estate, machinery, etc.).”60 To solve this problem, the authorities decided to introduce a drastic reform in the financial sector, the major aim of which was to generate negative real interest rates for a limited time in order to erode the value of existing bank loans and deposits.61 At the same time, new financial assets were created in order to give the public some protection against future inflation, and thus encourage the financial savings needed for new lending. In broad terms, the strategy called for a transitional period during which the financial system would have three main segments: a regulated segment, whose relative importance would fall over time as negative real rates shrank the value of its assets and liabilities until the segment disappeared altogether, and two other segments, one with free rates and the other indexed, whose combined relative importance would grow over time.

Although the financial system that emerged from these reforms was supposed to evolve back to a free system, later adjustments moved it in the opposite direction: the regulated segment grew in size while the free segment languished. Finally, in August 1983 the Central Bank prohibited the acceptance of any new deposits for the free segment, which was phased out as outstanding deposits matured.

The effects of the reform on the real value of the outstanding debt and on the size of the financial system were dramatic: negative real regulated rates eroded the outstanding real value of bank loans and reduced the demand for financial assets. Table 10 shows that the real value of debt deflated by the WPI had fallen by almost 37 percent between the second and fourth quarters of 1982 and by 62 percent by the end of 1984; all the other deflators in that table give a similar picture. Moreover, the size of the banking system shrank significantly below its prereform size, as measured by the real value of loans and deposits (Table 14). Table 14 shows that the real claims of the system on the private sector outstanding by the end of 1982 represented only 85 percent of those outstanding in June 1982, a proportion that fell to 70 percent by the end of 1983 and to 63 percent by the end of 1984. For total claims (i.e., including claims on the Central Government) the corresponding figures are 65 percent for the end of 1983 and 60 percent for the end of 1984. Moreover, the proportion of total claims financed by private sector peso deposits declined from 39 percent in June 1982 to 26 percent three months later, and then began to increase—but without reaching the levels that existed during most of the financial liberalization experience.

Table 15 presents quarterly data on deseasonalized monetary aggregates in real terms, for the period beginning in the first quarter of 1977 through the fourth quarter of 1984. Two major conclusions can be drawn from that table. First, although the crisis caused monetary aggregates to fall in the second quarter of 1980, there was a recovery in the third quarter, when M2 reached its peak for the whole period included in Table 15. Also, the fall in the demand for monetary aggregates became increasingly pronounced between the fourth quarter of 1980 and the second quarter of 1981. These two facts suggest that uncertainty about economic policies (related to an impending change in administration) was more important than the earlier bank failures in undermining people’s willingness to hold peso-denominated assets. Second, only after the reintroduction of interest rate controls in the third quarter of 1982 did quasi-money and M2 fall below the levels they had reached immediately before the liberalization.

Table 14.Evolution of the Banking System(In thousands of australes)
Real Claims of the

Banking System1
Share Funded by

Domestic Currency Deposits
End of

On private

TotalOf claims on

private sector
Of total

Source: International Monetary Fund, International Financial Statistics.

Deflated by the WPI.

Source: International Monetary Fund, International Financial Statistics.

Deflated by the WPI.

Table 15.Monetary Aggregates in Real Terms, Deflated by the CPI, 1977–84(In thousands of australes)
Source: Central Bank of Argentina, Boletín Estadístico, various issues.

Quarterly average of end-of-month balances.

M1 = Currency in circulation plus demand deposits of the private sector.

Quasi-money: Savings and time deposits and “other deposits” of the private sector (accrued interest is a major component of “other deposits”).

M2 = M1 plus quasi-money.

Source: Central Bank of Argentina, Boletín Estadístico, various issues.

Quarterly average of end-of-month balances.

M1 = Currency in circulation plus demand deposits of the private sector.

Quasi-money: Savings and time deposits and “other deposits” of the private sector (accrued interest is a major component of “other deposits”).

M2 = M1 plus quasi-money.

As the system shrank, banks had to rely less on the public for their funding and more on the central bank rediscount, which became a major source of funding.62 Also, as the importance of bank lending fell, the market sought alternative financial sources. Some, like bank acceptances, went through official channels; others, like inter-enterprise loans, did not. Lack of information on these alternative sources prevents us from analyzing them in this paper. As a general proposition, however, a financial market with regulated and unregulated segments entails a loss of economic welfare and macroeconomic control, compared with a free, integrated market. In particular, financial savings will tend to be lower and the cost of capital higher, on average, because of the market imperfections created by the segmentation.

Besides relieving the burden of domestic currency debts, successive administrations also took measures to relieve the burden of foreign currency debts. One of the first measures was to compensate some borrowers for the increase in the domestic currency value of their debts that resulted from the devaluation of June 1981. This compensation covered debts incurred or renewed between January 1 and May 29, 1981 that matured until the end of that year, provided that the debts were rolled over for at least one year. In addition, the Central Bank established an exchange insurance scheme that subsidized borrowers insofar as the premium charged was below the actual rate of devaluation.63 Over time, the scheme was enlarged and made even more attractive as Argentina’s reserve position deteriorated and the authorities tried to induce borrowers to renew their foreign credits.

Measures to Restructure the Financial System. The Central Bank acted to facilitate the restructuring of the financial system not only by liquidating failed financial institutions but also by encouraging mergers and sales and by increasing the Bank’s own flexibility to deal with problem institutions.

In October 1980 the Central Bank established a special line of credit to finance a fraction of the cost of mergers and purchases of financial institutions. The financed fraction could vary in each case and the interest rate on this line of credit was below market rates.64 Later, the Central Bank created a formal service to help financial institutions meet partners for mergers or purchases.

In 1982, a new law broadened the powers of the Central Bank to deal with problem financial institutions. The purpose of this law was to give more flexibility to the Central Bank, which, under the old law, had very few options besides liquidating insolvent financial institutions. Liquidation has always been the last-resort remedy provided by the Argentine banking legislation to deal with institutions in serious difficulties; in addition, liquidation has been the most severe penalty that could be inflicted on a financial institution. When the Central Bank approves the liquidation of a financial institution, a liquidator—usually from the Central Bank staff—is appointed to replace the chief executive officer and the board of directors of the institution. The liquidator’s first task is to pay the insured part of maturing deposits with funds advanced by the Central Bank.65 The liquidator does not make new loans but is responsible for collecting those outstanding as they mature. The liquidator also has broad powers in administering the institution on a day-to-day basis, subject to the approval of senior central bank management. The liquidator’s task is completed once court approval has been obtained for the final disposition of the institution’s assets and liabilities.

The liquidation process is quite costly. First, announcement of the liquidation of a large financial institution can create a confidence crisis. Second, both depositors and borrowers have to transfer their business to another institution. Third, funds advanced by the Central Bank for the liquidation are a source of monetary expansion that may be difficult to sterilize. Fourth, the physical and human resources that were employed by the liquidated institution may lay idle for a relatively long time. Fifth, borrowers tend to give relatively low priority to repaying loans made by a liquidated bank, because they prefer to honor their commitments to operating banks, which can provide new credits; this attitude introduces a rigidity in credit distribution in favor of the clients of the liquidated institution. Sixth, the cost escalates if the liquidated institution has acquired assets from bankrupt borrowers that must be administered by the liquidator. Few liquidators have expertise in administering assets that belonged to the bankrupt borrower (e.g., a steel mill), but many liquidators have had to deal with such a situation.

Because liquidation proved to be a rather costly solution to the problems of financial institutions, the new law was intended to reduce the need for liquidation by allowing different solutions to be applied at the discretion of the Central Bank.66 For instance, the Central Bank could authorize one sound financial institution to administer a troubled institution for a given period of time, at the end of which the first institution had the option of purchasing the second.67 In addition, the Central Bank was granted explicit powers to intervene troubled financial institutions; the Bank had exercised such powers since the crisis started but their legality had been challenged. The new law also expanded the Central Bank’s choices in liquidation cases: for example, the Bank could decide to liquidate an institution without revoking the institution’s charter.

The financial crisis and the actions of the Central Bank added impetus to the restructuring of the financial system that was already under way when the crisis began. The number of nonbank financial institutions fell sharply beginning in 1979, largely as a result of mergers, transformation into banks, or absorption by banks; also, 97 institutions were liquidated between May 1977 and December 1983. The number of banks increased almost continuously until 1981, but this increase was more than offset by the decrease in the number of nonbank financial institutions. Despite the reduction in the total number of financial institutions, however, the number of branches increased steadily throughout the period.

Steps to Streamline the Liquidation Process

The Central Bank tried several mechanisms to shorten the length and reduce the cost of the liquidation process. The law approved in 1982 had authorized the Bank to sell the assets of failed institutions under the terms and conditions that it deemed most appropriate. It also specifically allowed the Bank to delegate to other financial institutions the task of collecting the loans made by failed institutions. Thus, by 1985, the Central Bank had arranged for some government-owned commercial banks to manage 39 portfolios of failed institutions, but the results were disappointing. Therefore, following the recommendations of an ad hoc advisory commission, the Central Bank began to allow private banks to purchase the portfolios of some failed institutions or to administer them on behalf of the Central Bank. When portfolios were sold, however, the selling price reflected a discount as high as 80 percent of the face value of the loans.68 Also, in order to speed up the sale of the real estate held by the Central Bank (which had probably become the largest landlord in the country), the Bank provided preferential financing to buyers. These advantages, together with a more aggressive sales attitude, resulted in the sale of more than 1,500 real estate units between 1985 and 1987—a pace that accelerated later. Before 1985, only 500 units had been sold out of a total of about 5,200 that had been received by the Central Bank.69

Beginning in December 1987, the Central Bank also began to sell branches of banks under liquidation. These branches were sold as operating units, and their staff transferred to the purchasing bank. This practice allowed the purchasing banks to expand at a time when it was very difficult to obtain central bank approval for new branches.

Effects of the Crisis on Monetary and Credit Policy

The measures that the Central Bank took to cope with the crisis had important implications for monetary and credit policy. The immediate effect was a significant change in the sources of reserve money: as Table 16 shows, central bank loans to the financial system were equivalent to less than 2 percent of reserve money just before the crisis began (February 29, 1980). But that share increased dramatically once the Central Bank started to aid troubled financial institutions: by the end of April 1980 it had jumped to almost 31 percent, and at the end of the year it exceeded 50 percent. During 1981 and 1982 it kept increasing. The need to accommodate financial institutions—and, at a second stage, borrowers—put a heavy burden on the Central Bank. The rapid growth in credit to financial institutions, coupled with faster growth in credit to the Government, resulted in a jump in central bank domestic credit (Table 17). Moreover, net international reserves of the Central Bank fell by US$2.9 billion in 1980, US$3.5 billion in 1981, and US$5.5 billion (including accumulated arrears) in 1982.

Table 16.Changes in Sources of Base Money Creation, Selected Months, 1980–83(In percent)
DateRatio of Central Bank Loans

to Financial Institutions

to Reserve Money
February 29, 19801.87
March 31, 19802.76
April 30, 198030.82
June 30, 198032.24
December 30, 198050.12
December 30, 198181.61
December 30, 1982110.11
December 30, 198369.03
Source: Central Bank of Argentina, Boletín Estadístico and Memoria Anual, various issues.
Source: Central Bank of Argentina, Boletín Estadístico and Memoria Anual, various issues.

Part of this loss of reserves—and the contemporaneous acceleration in inflation—can be attributed to the faster expansion in net domestic credit of the financial system that started in 1981. Another cause of the loss was the fall in demand for peso-denominated assets that resulted from a loss of confidence in the value of the peso. The financial crisis and the measures taken to cope with it were major factors in this loss of confidence. First, the public realized that a bank failure could entail losses to depositors.70 Second, it also realized that much of the financial system was unsound, and that any measures taken to solve the problems were likely to entail losses to holders of financial assets in pesos. These losses would occur because (a) the Central Bank would be forced to provide assistance to distressed financial institutions (or final borrowers), and this assistance could lead to excessive monetary expansion, immediately if financed by expanding the money supply, or later if financed by issuing interest-bearing debt; or (b) interest rate regulation could be used to erode the real value of the assets and liabilities of financial institutions by generating negative real interest rates.

Table 17.Sources of Expansion of Central Bank Liabilities, 1977–84(In percent)
End-of-Year Data
In reserve money
Net foreign assets48.3387.08129.7465.7161.3936.9114.5930.65
Net claims on the
Claims on financial
In total central bank liabilities
Net foreign assets47.2863.2776.7238.7825.8921.248.8515.38
Net claims on the
Claims on financial
Source: International Monetary Fund, International Financial Statistics Yearbook, 1985.
Source: International Monetary Fund, International Financial Statistics Yearbook, 1985.

Costs and Distribution Effects of the Crisis

It is easy to list the types of costs generated by the financial crisis: welfare losses of lower money balances, temporary disruptions of the credit and payments system, deterioration and unemployment of the physical assets of failed financial institutions and bankrupt borrowers, unemployment of labor, misallocation of credit, untimely capital outflows, and the like. The list would be even longer if wealth and income redistribution effects were also considered, but complete quantification of these costs and distribution effects is practically impossible: not only is it hard to identify many of these categories, but also data often are unavailable. Nevertheless, this section presents some estimates to illustrate typical costs and effects.

Costs to the Central Bank of Liquidating a Financial Institution. When the Central Bank liquidates an institution, it advances the funds needed to pay back all insured deposits and it bears the cost of administering the institution until the liquidation process is finished. Because this process ends only when all assets, including loans, have been sold or recovered, it usually takes several years. Only when the process is completed can the Central Bank get reimbursement for its advances and other expenses, but only to the extent that the liquidated institution had valuable assets.71 Typically, the Bank cannot recover the full value, at constant prices, of its advances and expenses. Few figures are published on the losses incurred by the Central Bank in this regard. Moreover, the process of liquidation is still unfinished for most of the financial institutions that have been closed since the financial crisis began. However, each year the Central Bank sets aside reserves to cover the estimated cost of various contingencies. By the end of 1982, the reserves earmarked to cover losses from the liquidation of financial institutions totaled the equivalent of US$364 million. This figure underestimates the true expected losses because the Bank can also use non-earmarked reserves to cover such losses.

Wealth Redistribution Effects. Some of the data just discussed suggest that significant wealth redistribution effects took place during the period under analysis, even before the crisis came into the open. For instance, the movements in relative prices, particularly those of assets and liabilities, undoubtedly entailed redistribution of wealth among the owners of real and financial assets. Moreover, the crisis also had wealth effects, for example, on holders of foreign currency deposits, which were uninsured. Finally, many of the measures taken to cope with the crisis gave rise to a further wealth redistribution. For example, exchange rate insurance transferred the cost of devaluation from those enterprises that had borrowed abroad to the Central Bank. Given the complexity of wealth redistribution effects and the difficulty in obtaining relevant data, only one particular measure—the introduction of interest rate controls in July 1982—will be discussed here. These controls caused significant redistribution of wealth because they resulted in negative real rates, which eroded the value of existing loans and deposits in the financial system.72

Table 18 presents data for 1982 and 1983, which illustrate the size of these effects. The first two columns show the implicit subsidy for borrowers, measured as the difference between the flow of interest accrued at the regulated rate and the flow that would have accrued in the absence of interest rate regulation. There are two columns because the latter flow is defined according to two alternative assumptions about the nominal interest rate: (a) equal to the rate of inflation (wholesale prices); and (b) equal to the nominal rate that would reflect the average real lending rate that prevailed in the liberalization period (June 1977-June 1982). A similar procedure is used in the third, fourth, and fifth columns to estimate the cost to depositors; for checking deposits, only the rate of inflation alternative is used. The estimates in the table indicate that in the one and a half years under consideration borrowers benefited from an income transfer that ranged between 10.8 and 13.4 percent of GDP, while holders of time and savings deposits lost between 8.3 and 8.9 percent, and holders of checking deposits lost about 4.4 percent of GDP. These substantial redistributions have extended beyond the period covered in Table 18, although the size of the yearly redistribution has probably been falling as the size of the financial system shrank in real terms. As noted at the time by the authorities, however, this redistribution of wealth between holders of financial assets and liabilities through the measures adopted in July 1982 could be regarded as an acknowledgment of the reality that many borrowers could not repay the full value of their debts, necessitating a corresponding reduction in the value of deposits.

Table 18.Initial Wealth Redistribution Effects of 1982 Interest Rate Regulation of Commercial and Savings Banks, 1982–83
Depositor Cost
Borrower Subsidy

with Respect to
Time and savings


Real lending


WPIReal deposit




(As percent of GDP)
Total for
Sources: Central Bank of Argentina, Boletín Estadtístico, various issues; data furnished by the Central Bank of Argentina; and author’s own estimates.

In columns (3) and (4) savings accounts are assumed to earn the same rate of interest as ti me deposits.

Sources: Central Bank of Argentina, Boletín Estadtístico, various issues; data furnished by the Central Bank of Argentina; and author’s own estimates.

In columns (3) and (4) savings accounts are assumed to earn the same rate of interest as ti me deposits.

IV. Summary and Conclusions

Because this study has covered a broad range of issues, it is useful to summarize its main points before drawing more general conclusions:

  • The financial crisis occurred after a period of economic expansion, which was uneven by sector and during which substantial changes in relative prices took place.
  • There is no evidence of a monetary contraction that could have caused the financial crisis, as some authors have claimed was the case during the U.S. crisis of the 1930s. On the contrary, monetary aggregates were growing rapidly before the crisis began and continued to do so thereafter.
  • When interest rate ceilings were lifted in 1977, nominal interest rates more than doubled and remained significantly higher and more variable than controlled rates had been. This variability was lower during the period of preannounced devaluations.
  • High real lending rates helped to precipitate and aggravate the crisis, but because negative real rates prevailed in many periods, the effects of real rates on borrowers varied according to the timing of their borrowing.
  • Although lending rates fluctuated with deposit rates, large and volatile spreads had a major influence on them. These spreads largely reflected the gross margin that served to cover administrative costs and profits. Risk premiums and monopolistic behavior are hypotheses that could explain these margins, but they are not tested in this chapter.
  • Imperfect access to foreign loans and uncertainty over exchange rate policies can explain why borrowers continued borrowing domestically.
  • Financing of high-yield and high-risk projects, expectations of a bailout, and speculative borrowing are the main hypotheses that have been advanced to explain borrowing at high real rates, as observed in Argentina.
  • The policy of preannounced exchange rates—and to a lesser extent, trade policies—substantially increased the price of nontradable goods relative to tradable goods beginning in early 1979 and lasting until the exchange rate policy was changed in 1981. The policy changes forced enterprises to adapt to a dramatically changed economic environment; this adaptation was made more difficult by growing uncertainty about the sustainability of exchange and trade policies.
  • Stock prices, which had been increasing significantly before the financial crisis started, dropped immediately thereafter, both vis-à-vis the wholesale price index and the dollar. This drop made access to finance more difficult for enterprises just when lenders became more cautious and lending rates were high in real terms.
  • The debt burden, measured as the ratio of a hypothetical debt to selected prices, shows substantial variability over the liberalization period. Nevertheless, the burden continuously increased, in terms of foreign currency, between the first quarter of 1977 and the first quarter of 1981, when the situation reversed itself as a result of the devaluation. Thus, whether a firm was better off by borrowing in domestic currency or in dollars hinged on the period over which the debt was outstanding. Also, between the first quarter of 1980 and the second quarter of 1982, the debt burden for homeowners more than doubled; this burden became a major argument in favor of debt relief at the time.
  • Distress borrowing aggravated the crisis, but its influence in starting the crisis is unclear. Some evidence suggests that when enterprise profitability fell, beginning in 1980, gearing ratios increased.
  • Business failures increased during the liberalization period and jumped when the crisis broke out in 1980; industry was the most affected sector.
  • The financial reform of 1977 not only freed interest rates but fostered competition by liberalizing entry into the financial market and the opening of branches.
  • The abandonment of full deposit insurance in November 1979 made deposits riskier and helped to propagate the crisis, until mid-April 1980, when full insurance for most deposits was re-established. Reluctance of the interbank market to lend to troubled institutions contributed to propagating the crisis.
  • The prudential regulations and penalties for noncompliance that were in effect during the liberalization period were fairly comprehensive, but the emphasis in supervision was on monitoring compliance with regulation more than on analyzing the quality of the portfolio of financial institutions. Indicators that might have given advance warning on troubled institutions were not available until 1981. Moreover, the percentage of institutions inspected on site fell between 1977 and 1981.
  • Bank reports indicated a steady deterioration in bank portfolios, starting in 1976 but accelerating dramatically in 1980.
  • The emergency measures taken by the Central Bank succeeded in stopping the run on deposits that started with the Banco de Intercambio Regional’s liquidation.
  • Some evidence suggests that currency holdings became less elastic to the deposit interest rate after the start of the crisis. Also, uncertainty over the course of economic policy late in 1980 and early in 1981 appears to have been more important than bank failures in reducing the demand for monetary aggregates.
  • The Central Bank adopted various measures over time to provide debt relief to the private sector. In 1980 and 1981 the Bank implemented schemes to encourage banks to refinance outstanding loans. In July 1982 it took a more drastic approach, the main elements of which were interest rate ceilings on most financial assets and debt refinancing. Also, the Bank provided inducement, such as exchange rate insurance, to encourage the rescheduling of foreign debts.
  • The reintroduction of interest rate controls in 1982 was coupled with a rise in the inflation rate. The resulting negative real interest rates caused a dramatic fall in the value of the outstanding stock of debt and a fall in the demand for monetary assets. At the same time, central bank credit became a major source of funding for the financial system and of growth of reserve money. This situation contributed to the loss of reserves and the rise in inflation experienced after the crisis started.
  • The Central Bank established new facilities, including credit lines, to facilitate absorptions and mergers. The costs implicit in liquidating financial institutions, which was the remedy mandated by law in some situations, induced the Government to give more flexibility to the Central Bank in dealing with troubled institutions, and the Bank to devise means to speed up the liquidation process.
  • Figures for the cost of bank liquidations are hard to obtain. By the end of 1982, the Central Bank had earmarked provisions equivalent to about US$364 million, which probably underestimates the cost. Moreover, the costs of keeping resources idle or using them suboptimally are impossible to estimate. These resources include not only typical bank assets such as bank buildings and computers but also property acquired by banks through foreclosure that the Central Bank has to manage in the case of failed banks.
  • The financial crisis and the measures taken to cope with it entailed significant redistribution of wealth. Depositors in foreign exchange in failed institutions lost their deposits. A further redistribution resulted from the negative real rates that prevailed after interest rate controls were reintroduced. The latter redistribution transferred the equivalent of at least 11 percent of GDP to borrowers over one and a half years.

A broad conclusion that can be drawn from the analysis is that, although elements endogenous to the financial system, such as the high level of interest rates following the liberalization and loans of dubious quality, contributed to the crisis, elements exogenous to the system played a major role in determining the extent of the crisis. Macroeconomic policies, particularly with regard to the exchange rate, forced enterprises to adjust to substantial changes in economic conditions. Uncertainty about policy continuity exacerbated the costs of adjustment. These elements contributed to a recession and to the collapse of many firms, which, in turn, caused the quality of the loan portfolio of the financial system to deteriorate.

Inadequate supervision of the financial system also contributed to the crisis. Financial institutions that were liquidated in the early stages of the crisis had particular problems that early warning indicators and closer monitoring could have detected more promptly. Earlier detection not only would have given more time to find solutions but also could have reduced the size of the problem by limiting the growth of those institutions. But even with better supervision, some deterioration of the quality of bank portfolios could not have been avoided in light of the instability of economic conditions that made forecasting and planning very uncertain. Be that as it may, there is little doubt that improved supervision would have enabled the financial system to withstand such deterioration better.

The Central Bank was able to contain the propagation of the crisis by granting emergency credits to troubled institutions and by eventually reversing its previous policy of gradually reducing the scope of deposit insurance. The crisis gave impetus to improvements in bank supervision and prompted the introduction of more flexible ways to deal with troubled institutions in order to reduce the need for the inherently costly liquidations. Measures to speed up the liquidation process had mixed success; the most promising of such measures appear to have been the sales of branches as operating units, sales of real estate, and sales of failed institutions’ portfolios.

The reintroduction of interest rate controls brought relief to borrowers but it also shrank the size of the financial system, as depositors became reluctant to hold financial assets carrying a negative real yield. This situation, together with other measures taken to help borrowers and financial institutions, such as increased central bank funding of the financial system, undoubtedly made monetary management more difficult and contributed to the higher inflation and loss of international reserves that had started with the crisis. The huge debt relief granted in 1982 also raises difficult questions about the fairness of the substantial redistribution of wealth that it entailed and about the extent to which more selective relief could have improved bank portfolios and helped problem borrowers at less cost.


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1I wish to thank Daw it Makonnen for valuable research assistance and Jose A. Uriarte of the Central Bank of Argentina for his help in obtaining and interpreting some of the data.
2Intervention is the power of the central bank to appoint an administrator who displaces the existing administration of a troubled financial institution. (The property of the institution remains with its original owners.) Intervention can be a first step toward liquidation or toward reorganization and sale of the institution.
3See, for example, Ardito Barletta, Blejer, and Landau.
4Fernández (1983a and 1983b). Similar views, in a broader context, appear in Fernández (1985).
5The reference cycles have been estimated with the methodology used by the National Bureau of Economic Research for its studies on U.S. business cycles.
6See Baliño (1987), pp. 8 and V.
7Domestic credit is the variable that the Government could control throughout most of the period because international reserves were endogenous, with the Government setting the exchange rate.
8See, for instance, Friedman and Schwartz (1963) and Cagan (1965).
9The 1982 outliers should be disregarded because they reflected the economic and political uncertainties of that year (conflict over the Falkland Islands/Maivinas; change in administration), as well as the reforms introduced to the financial system by midyear. The figure for the second quarter of 1977 should also be disregarded, because it reflects the transitional effect of moving from a 100 percent reserve system to the fractional system rather than the effect of bank decisions.
10The Argentine banks’ behavior contrasts sharply with the behavior of U.S. banks during the 1930s, when they increased their excess reserves, thus reducing the money supply and deepening the recession, in the view of monetarist writers such as Friedman and Schwartz (1963).
11Also, many studies have pointed to high real interest rates as evidence of the failure of the liberalization experience. See, for instance, Diaz-Alejandro(1985).
12See Baliño(1987), p. 14.
13See, for example, World Bank (1984).
14The increase in the real size of the financial market reflected not only the growth of loans to old bank clients but also lending to new borrowers, some of which operated in fields that became more dynamic as a result of the change in relative prices described later in this chapter. Also, personal loans and mortgage loans gained much importance. It is worth noting that, for long periods before the liberalization, banks were not allowed to make personal loans for consumption.
15Such borrowers would be investing in risky projects with a high expected rate of return. Therefore, they would be prepared to borrow even at a high rate, because in case of failure they would default on their loan but in case of success they would keep the entire profit.
16For the bailout explanation see, for instance, Calvo (1986).
17A major problem would be to obtain the required data. For instance, the data on spreads before and after June 1977 cannot be easily compared because lending rates before that date were accompanied by credit rationing, which involved practices like compensating balances which increased the actual cost of borrowing.
18See, for instance, Rodriguez (1982) and Feldman (1983).
19On February 2, 1981 the Central Bank devalued the peso by 10 percent despite having announced in October 1980 that the monthly devaluation rate for that month and the following months—with no specified time limit—would be 1 percent.
20See World Bank (1984), p. 207. A derailed discussion of distress borrowing is presented in Dreizzen (1984) and in Fernández (1985).
21Prices had been rising about 7-8 percent a month between the last quarter of 1977 and the last quarter of 1978.
22Moreover, the bank failures had begun to erode public confidence in the course of the economy.
23In practice, the Central Bank followed a “crawling peg” policy to adjust the commercial rate, while it also intervened to some extent in the financial market.
24These dates mark the period when the policy of preannounced devaluations was fully implemented.
25Notice the difference in the real wage changes measured with the CPI and WPI. Real wage increases were lower using the CPI probably because services and nontradables have a heavier weight in that price index.
26For a detailed evolution of real wages, see Baliño (1987), p. 27.
27In the case of Chile, Meller and Solimano (1983) agree that “speculative elements and high real interest rates” were responsible for the crisis of the financial system. Their tests suggest the existence of a speculative bubble in the Chilean stock market.
28Failing asset prices have been blamed for some bank crises, such as the “wildcat banking crisis.” See Rolnick and Weber (1984).
29This appreciation did not result from higher costs of construction. Although construction costs increased faster than wholesale prices, the ratio of the two indices increased by only 8.5 percent between June 1977 and March 1980 and by 35.6 percent between June 1977 and December 1980.
30The price of cattle was included because it was one of the most important asset prices in the Argentine economy for which data were available. However, cattle prices are subject to the livestock cycle, so their level depends to an important extent on the decisions on stocks taken some time before.
31For instance, the coefficient of variation for the data in the second column equaled 0.524 for monthly data between January 1977 and December 1984.
32The monthly series allow for a more precise dating of the trough in October 1977.
33It is assumed that interest on the loan, at the average lending rate, is compounded monthly and that there are no payments of interest or principal until the loan matures. Because loans in Argentina were made at an adjustable rate, both new and old loans paid the same rates.
34The value of the loan is set equal to one in January 1978.
35The devaluation of the domestic currency helped to restore the competitiveness of many firms but also increased the debt burden of those that had borrowed in foreign currency. The latter obtained debt relief later.
36The data in column 2 are easier to interpret than those in column 3, which require two special—though plausible—assumptions: that financial liabilities in failed firms can be proxied by total liabilities and that business failures in the entire country can be proxied by business failures in Buenos Aires.
37Batino(l987), p. 35.
38similar system had existed between 1946 and 1957 (see Baliño (1982)).
39The Central Bank paid a commission to commercial banks as compensation for the administrative cost of deposits.
40The Central Bank also set maximum fees and commissions on other bank operations.
41Indexed bonds issued by the Treasury coexisted with nonindexed assets: the former became very popular as a hedge against an increasing and volatile rate of inflation.
42State banks, however, were free to open new branches within their jurisdiction, subject only to a communication to the Central Bank.
43Argentine legislation has traditionally vested the powers of chartering, bank regulation, and supervision in the Central Bank.
45The conversion to the fractional reserve scheme became effective as of June 1,1977.
46For new institutions, the limit was set at 50 percent initially and increased it) points annually until it reached 100 percent.
47It is interesting to note that the three banks that failed in March/April 1980, which included the largest private bank, as well as the largest nonbank financial institution in the country, which had failed in the previous year, all had their head offices in the interior and had used this preference to extend their branch network dramatically.
48The new regulations established that maximum lending to an individual client would fall gradually, to reach 5 percent of the bank’s capital as of January 1, 1980. The purpose of these changes, according to the Central Bank, was to allow financial institutions “to amply recover their rights to consider and determine, for each operation, the amounts of assistance technically appropriate to the activity and size of the borrower” (Central Bank of Argentina (1978, p. 15)).
49There was some hesitation in the Bank’s regulatory action. For instance, as of March 1, 1979 the Bank established that at least 50 percent of a financial institution’s portfolio had to be covered by domestic collateral or by guarantees from foreign banks. This requirement was dropped in late 1979 with the argument that financial “institutions [themselves should] determine the … collateral requirements to be provided by their borrower” (Central Bank of Argentina (1979, p. 17)).
50Equivalent to about US$640.
52The new system involved substantial changes in bank accounting and reporting, standardization of auditing procedures, and reorganization of the bank supervision area at the Central Bank.
53The authors define the “unit defensive position” as loans/deposits (1 - legal reserve requirement) and interpret it mainly as an indicator of bank capitalization. They are assuming implicitly that changes in other assets and liabilities (such as excess reserves or foreign exchange operations) do not distort the values of this indicator.
55Some of the interventions that took place in 1980 were challenged in count—unsuccessfully—because, at the time, the law did not grant explicit intervention powers to the Central Bank.
56Their only hope was that the failed bank would have some funds to repay dollar depositors, at least partially. once the liquidation proceedings were finished. But hank liquidations are usually lengthy proceedings, and in this case there was little chance that any funds would remain to pay hack dollar deposits.
57This period was longer than usual in the case of the Banco de Intercambio Regional owing to its extensive network and chaotic administration. The law only required the Central Bank to pay back insured deposits of a financial institution within 30 days of each deposit’s maturity. The depositor earned no interest over this period.
58The maximum size was increased from I million to 100 million pesos (10 australes), which at the time represented an increase from US$600 to US$60,000.
59Some estimates suggest that total private debt (gross debt, i.e., without subtracting private holdings of financial assets) had increased from about 18 percent of GDP in 1976 (year-end) to about 32 percent in 1980 and reached a peak of 39 percent in 1981. These figures are from Arriazu, Leone, and Lopez-Murphy (1985).
60Interview with Domingo Cavallo, President of the Central Bank of Argentina in July 1982 (de Pablo(1986)).
61Other measures taken simultaneously sought to encourage the refinancing of private foreign debt and to reduce further the attractiveness of public sector securities through the advance repayment of outstanding public debt denominated in pesos. Also, the peso was sharply devalued and the exchange market was split in two-—one market for commercial transactions and another for financial transactions.
62This increase in central bank funding began in 1981, when debt relief mechanisms were put in place.
63The criteria to calculate the premium varied over time, but two were used quite often: the wholesale price index and the domestic deposit interest rate. The subsidy in the insurance scheme resulted from the significant real depreciation of the peso over the period and from the fact that the domestic deposit rare did not fully reflect the peso depreciation. Moreover, in many cases borrowers could choose the criteria for the adjustment of their exchange insurance premium between at least two indices. The cost of the subsidies implicit in the insurance scheme was borne by the Central Bank, which also bore the losses caused by swaps.
64In 1981, 227.1 billion pesos were granted under this facility. To have an idea of its relative importance, in September 1981 the average capital and reserves of a private hank in the Province of Buenos Aires approached 16 billion pesos; the corresponding figure was lower for most other areas.
65The Central Bank usually recovers only a fraction, in real terms, of the funds so advanced. Such recovery takes place only as the credits made by the failed bank are repaid and other assets are sold.
66The Central Bank’s decisions can be appealed to the Ministry of Finance or to the courts.
67This solution was tried on one of the largest and oldest private banks, the Banco Español del Rio de la Plata, but the administering institution decided not to exercise its purchase option. The Banco Español was finally auctioned, and the buyer received central bank assistance for the purchase.
69Ibid., pp. 112-13.
70Even though most of these fears were allayed when practically full insurance for peso deposits was restored retroactively, dollar depositors in the Banco de Intercambio Regional have not vet recovered their deposits.
71Under the law, the Central Bank’s claims on failed financial institutions take precedence over other claims.
72As explained earlier, the maturity of outstanding debts also was extended.

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