Gabriel Loza Tellería: The role of central banks in macroprudential
regulation - the case of Bolivia
Opening remarks by Mr Gabriel Loza Tellería, Acting President of the Central Bank of
Bolivia, at the Primera Jornada de Estabilidad Financiera, La Paz, 29 September 2010.
* * *
Translated and slightly revised from the Spanish original, available at
www.bcb.gob.bo/jfinanciera/sites/default/files/presentaciones/GabrielLozaBolivia.pdf.
Today I will speak about the experience of Bolivia, a small, open, partially dollarized and
commodity export-oriented economy. Gathered here are representatives from the central
banks of Argentina, Brazil, Chile and Colombia with whom we usually meet within the
framework of Mercosur, CEMLA and FLAR to discuss not only monetary policy issues but
also issues regarding the financial system. I would like to highlight the presence of the Bank
for International Settlements' (BIS) Chief Representative for the Americas, because of the
close relationship we have been building in recent years. As you know, the BIS is the leader
in macroprudential regulation issues. I am also pleased to welcome the European Central
Bank, as well as the Bank of Spain. From Argentina, the Center for Financial Stability will
present us its private-sector point of view on the subject.
Macroprudential regulation is not an isolated issue, but is closely related to macroeconomic
policy, specifically central banks' monetary policy and so-called macroprudential policy
instruments, which are the general topic of this conference. We will be speaking about stress
tests and reviewing the experiences of Argentina and Bolivia, the latter as part of our
Financial Stability Report.
With regard to Bolivia, I would like to point out that our experience is perhaps not widely
known, and that, furthermore, each country's experience is unique. I will briefly highlight
some lessons from the international crisis and recent reforms in macroprudential regulation,
particularly the role of central bank in macroprudential regulation, then describe the Bolivian
experience, and finally draw some conclusions.
1. Lessons from the international crisis
One of the main lessons from the crisis is that, after Lehman, financial markets will not return
to their pre-crisis level. The most likely scenario is one of successive crises/shocks of
different magnitudes and intensities. Some experts, for instance Roubini, foresee a number
of big crises yet to come. Stock, bond and foreign exchange markets are currently
characterized by higher levels of volatility than those observed during the Lehman period.
After Lehman, world economies had to deal with the Greek crisis and, more recently, the
Irish one. Some financial stress has also been observed in emerging markets due to
transmission effects, although not of the magnitude seen in previous crises.
A recent work by Blanchard et al. (2010)1 questions the ability of policy makers to conduct
macroeconomic policy, and, among other things, concludes that one of the lessons of the
international crisis is that financial intermediation used to be considered - at least by most
economists - as not relevant, despite its importance for the credit channel and for the role of
central bank as lender of last resort. The financial system as such received little attention,
whereas emphasis was given to inflation targeting, low inflation and the role of interest rates.
Lessons drawn from the crisis suggest that financial intermediation is important and that
proper attention should be given to supervision and systemic regulation. On top of that,
central banks should follow household prices and other asset prices - in addition to
consumer prices - to prevent or take action during bubbles, like the one we have just seen in
the real estate sector in several advanced economies.
The policy interest rate, as a traditional instrument, was not enough to prevent the recession
and should be complemented with other instruments such as capital and leverage ratios.
Central banks have also asked themselves if they should have regulatory capabilities in
macroprudential issues. Recent experience points to using a variety of instruments for
several objectives, and within this mix of objectives and available tools macroprudential
regulation is a key issue. As I said before, the predominant opinion before the crisis was that
macroprudential regulation was not part of macroeconomic policy; instead, regulation had
mainly microeconomic objectives. In addition, since the 1990s there had been a trend
towards deregulation.
Another lesson from the crisis is that macroregulation is not neutral: insufficient regulation led
to the crisis, and it follows that it is necessary to combine monetary policy and regulation. In
addition, central banks should not only be responsible for monetary policy, but also for
macroprudential issues. In the end, we have learned that financial markets do not
necessarily move to equilibrium. Government intervention is necessary to achieve stability.
Macroeconomic policy alone was not sufficient to prevent the crisis, especially in advanced
economies.
Regulation should be one element alongside macroeconomic policy instruments: before the
crisis systemic risk was not trivial, it was latent, and it turned out to have been extremely
costly to have neglected this variable. Price stability is not a sufficient condition to guarantee
financial stability; the relationship between monetary and macroprudential policy should be
taken into account. What is required is: proper risk management, awareness of procyclicality
and of how risk is distributed, removing the notion of banks as "too big to fail", surveillance
and individual and systemic risk assessment, and awareness of credit growth.
2. Recent reforms and macroprudential regulation
I will only briefly summarize stylized facts, since throughout the conference we will dig
deeper into these issues. The establishment of the Financial Stability Board within the G20
framework was an excellent initiative, as was taking into account macroprudential risks and
the establishment of anticyclical capital buffers and a capital conservation buffer, among
others.
Some additional work was also undertaken by the Obama administration, in particular
updating the legal framework of the Federal Reserve and exit rules for big banks; enhancing
consumer and depositor protection; strengthening deposit insurance; regulating derivatives
markets; requiring a higher level of capital for banks; and improving control over credit rating
agencies (which ahead of the crisis did not work properly and could not send early warnings
to the markets).
There was, and still is, a debate about taxing banking activity, for instance in the U.S. and
Europe. Germany is assessing how to handle the social cost of future financial crises and
possible government intervention. We must decide who will face the burden of future crises.
Hence the current debate on taxing banking activity - although it is important to keep in mind
a global tax, since a mere national tax may lead to disequilibrium. The level of tax for each
country may be dependent on risk and the size of the financial system. We must be very
diligent in this, since imposing taxes does not in itself eliminate the possibility of future crises,
and coordination among countries may be required.
Regarding the reforms to the capital adequacy framework, known as Basel III, one lesson
drawn from the crisis was that financial institutions' capital was not enough to protect them
from losses. Currently, banks have to keep a Tier 1 (primary capital) of 4%. From 2013, this
proportion will be raised to 4.5% and to 6% in 2019. By the end of the decade, quality
reserves of banks should be around 8.5%.
In parallel, the European Union has made progress on transparency and safety of derivatives
trading, on regulating swaps and hedge funds and on improving a new framework for
banking supervision.
3. Prudential regulation and the role of central banks
In the end, the key issue is: what is the role of central banks in prudential regulation? If the
traditional approach has revealed itself to be narrow, then we need a systemic approach that
incorporates economic cycles and macroprudential regulation. In times of crisis, central
banks tend to react quickly, either because they have a mandate or because they are
lenders of last resort: central banks are usually the first to try to extinguish the fire. The
reason that underlies the former should be clear: central banks oversee monetary stability,
financial stability, macroeconomic policies (in our case, monetary and exchange rate policy)
and macroprudential regulation.
Several reasons point to the need for central banks to be involved in prudential regulation (in
Bolivia there is currently an institutional separation between the central bank and the
Financial Supervision Authority (ASFI)). Central banks have daily flows of information coming
not only from the financial system but also from the economy as a whole. Therefore,
monetary policy decisions should be made in coordination with those decisions related to the
macroprudential area in order to smooth the economic cycles. We should take preventive
measures before illness appears. The central bank's reputation plays a key role in systemic
regulation, as does its role of lender of last resort.
Nevertheless, there are some pending issues2:

What financial stability mandate should central banks have? Is there a need for a
new mandate in terms of macroprudential policy?

Close coordination with government agencies plays a fundamental role. In Bolivia,
we thought hard about the true meaning of central bank independence. Central
banks had to act immediately, pushed by governments. How do these relationships
impact on institutions and their management? Obviously, policy decisions regarding
financial stability have some political aspects: whether Lehman should be bailed out
or not, or whether any other corporation should be. There is still some debate about
this. We can discuss such issues for a long time after a given event, but taking
decisions at the right moment is harder to do.
Macroprudential policy is not a substitute for sound macroeconomic policies; macroprudential
policies alone do not fix everything, so there has to be close coordination. Who decides the
timing and the design of these policies? What is the relationship between the macro- and
microprudential issues?
4. The Bolivian experience
The consensus within the Bolivian financial system is that the international financial crisis did
not have a direct impact on our economy.
The Central Bank of Bolivia implicitly recognizes that financial stability is a public policy
objective, but not an end in itself. Financial stability has to contribute to the economic
development of the country. Our approach, therefore, includes close coordination between
the Ministry of Economy and Public Finance (Ministerio de Economía y Finanzas Públicas,
MEFP) and ASFI.
One of the factors that contributed to the small impact of the international crisis in Bolivia is
our low vulnerability - not only in the financial system, but also low fiscal and external
vulnerability. We were ready to face exogenous shocks a result of prudential and sound
macroeconomic management in the years before, during and after the crisis. The following
table shows some relevant data in this regard.
Ratios (%) Dec-08 Dec-09 Aug-10
Capital
Regulatory capital to risk-weighted assets 13,7 13,3 12,5
Nonperforming loans net of provisions to capital -7,7 -7,0 -8,5
Assets quality
Nonperforming loans to total loans 4,3 3,5 2,7
Provisions to nonperforming loans 132,3 135,5 147,5
Management
Administrative expenses to total assets 4,2 3,9 4,9
Administrative expenses to financial income 56,4 59,4 71,3
Earnings
Return on equity 18,7 19,6 20,2
Return on assets 1,7 1,7 1,7
Liquidity risk
Liquid assets to total assets 43,3 48,0 41,2
Liquid assets to short-term liabilities 91,2 96,8 82,2
Foreing investments to financial investments 10,3 17,9 18,0
Bolivianización
Loans in domestic currency to total loans 32,1 38,4 50,5
Deposits in domestic currency to total deposits 46,8 47,7 49,6
Foreign liabilities to total liabilities 3,8 2,8 2,2
As can be noted, the Bolivian financial system has sound capital, adequate asset quality and
profitability ratios, as well as good ratios of deposits and loans in local currency relative to
foreign currency - which is something I would like to highlight. The Bolivian case is still the
one of a highly dollarized economy. Financial dollarization, i.e., deposits and loans in foreign
currency, used to be around 90% of total deposits and loans. As a result of close
coordination among the central bank, MEFP and ASFI, the ratios of loans and deposits in
domestic currency over total loans and deposits are, for the first time in several decades, a
little higher than 50% for loans and close to 50% for deposits. Banks' foreign currency
liabilities are less than 3% of total liabilities due to low involvement in international financial
markets, as explained before.
In Bolivia we view financial regulation as important. The prudential regulation measures
taken by the Central Bank of Bolivia have improved in recent years and have been closely
coordinated internally (monetary and exchange rate policies) and with the MEFP and ASFI.
The challenge ahead is to give this coordination a more formal framework. What are the
decisions we should make to arrive at coordinated results and decisions?
On the one hand, our experience is based upon a sound macroeconomic policy: current
account and fiscal surplus, price and foreign exchange stability. On the other,
microprudential analysis is performed with emphasis on individual entities, while we also
perform macroprudential analysis, for example, our Financial Stability Report, which includes
an analysis of stress tests.
The following chart uses an approach presented by the governor of the central bank of
Argentina at the conference "Jornadas financieras y bancarias 2010". It is based upon the
following variables: current account, financial regulation, exchange rate flexibility, monetary
policy, fiscal policy and net foreign asset accumulation. As can be seen, before the crisis,
emphasis was on monetary policy and exchange rate flexibility. The exchange rate was
endogenous and little progress was made in capital account and financial regulation; net
foreign asset accumulation and fiscal policy were not that important before the crisis. Bolivia,
before the crisis, had a broader scope on these issues.
Exchange rate stability and net foreign asset accumulation policy were very important for us.
This policy has led us to reach the current level of $9 billion in international reserves (45% of
GDP). Some of the central banks represented here will be telling us their experiences in this
area. Colombia and Mexico would be cases worth hearing about.
Adequate fiscal policy led to consecutive fiscal surpluses. In order to manage capital flows,
the Central Bank of Bolivia imposes fees of 1% for outflows and 0.6% for inflows. These
measures have been carefully analyzed, and the Bank continues to monitor them closely. In
the wake of the crisis, recommendations have pointed to an equilibrated approach, and we
have followed this line.
Rethinking macroeconomic policy and lessons from the crisis
Before the crisis
Regulación Cuenta Capital
Capital account regulation
1 0 0
9 0
8 0
7 0
6 0
5 0
Exchange Exchanege rate rate flexibility flexibility
Flexibilidad Cambiaria Regulación Financiera
Financialregulation
4 0
3 0
2 0
1 0
0
Política Monetaria control de la inflación Acumulación de reservas
Monetarypolicy International reserves
accumulation
Política Fiscal
Fiscal policy
Consenso internacional antes de la crisis Bolivia
Pre crisis internationalconsensus
After the crisis
Regulación Cuenta Capital
Capital account regulation
1 0 0
9 0
8 0
7 0
6 0
5 0
Exchange Exchanege Flexibilidad rate rate flexibility flexibility Cambiaria Regulación Financiera
Financialregulation
4 0
3 0
2 0
1 0
0
Política Monetaria control de la
Monetarypolicy Acumulación de reservas
inflación International reserves
accumulation
Política Fiscal
Nuevos planteamientos a partir de la crisis internacional Bolivia
Post crisis proposals
5. Conclusion
The financial crisis is not over; we are not going back to pre-crisis levels, and the financial
environment will continue to be one of uncertainty. The challenge for central banks is to
make monetary and macroprudential policies in times of stress. The current lack of
macrofinancial regulation is part of the problem, but it is not the only one. There are market
failures, but it is not possible to assess their intensity: there was not an automatic adjustment
or a smooth transition back to equilibrium; there were also drawbacks derived from dominant
macroeconomic policy thinking. Financial stability should be a public policy goal and a means
to stimulate economic growth. In this context, that the role of the central bank is important:
monetary stability is not enough, and sound macroeconomic and macroprudential policies to
promote financial stability are needed. Integrated market regulation and supervision should
include all agents and instruments as well as oversee leverage, liquidity and provisions.
Macroprudential regulation is still in the process of being defined, and it is a pertinent issue. It
is necessary to define and identify its tools and aims. As usual, these definitions should be
done case by case, with a pragmatic approach.
I would like to thank you all for your presence at this conference, and I would like to extend a
particular welcome to the university students in the audience, because ultimately you will be
able to apply the information disseminated today, since you are, in the last analysis, the final
users of the information. We have a very large audience today, and may I now invite all our
speakers to share their experiences. Thank you very much.