Integration or Fragmentation? International Capital Flows in the Post-crisis World
How the Revised OECD Codes Can Improve Transparency, Accountability, Credibility, and Trust
Session : "Next Vulnerabilities: Capital Flows and the Migration of Risks to New Corners of the Financial System"
September 11, 2019 - OECD Conference Centre, Paris, France
"Capital Flows and the Migration of Risks: The Recent Chilean Experience"
Remarks by Mario Marcel, Governor of the Central Bank of Chile
1. Issues for discussion
a. Which new sources of vulnerabilities are building up a decade after the 2008 crisis?
- Risks associated with the growing importance of non-bank lenders. In some EMEs, this may result in
credit lending going informal due to a relatively higher cost in credit provision due to regulation.
- Risks that can emerge from a less developed financial infrastructures outside the regulatory
perimeter.
- Risks attributed to disruptive FinTech activities, such as the development of crypto-assets markets, as
well as cybersecurity issues.
- Risks and challenges associated with the changing nature of banks' business model. In particular,
those coming from the internationalization of banks' activities.
b. How to better consider a cost-benefit framework for financial regulation, such as currency-based
measures (CBM)?
- While the banking regulation and supervision arising from the 80s-banking crisis was restrictive in
several ways, it was supported by sound monetary and fiscal policies.
- In addition, the development of pension funds, mutual funds, and insurance companies, provided
support for banks' funding needs, and help to develop the FX derivative market that has allowed both,
banks and corporations to deal with currency exposure without the need of imposing currency-based
measures as we have observed in other emerging economies (this includes regulations imposing a
different treatment between domestic and FX-denominated operations by banks, such as reserve
requirements on FX denominated banks' deposits).
- Because of this, over the past decades, and despite global financial turmoil and crises, the size of the
Chilean-banking system has increased steadily to reach levels similar to developed economies.
c. Which policy actions could ensure the stability of unregulated corners of the financial system without
affecting negatively global financial integration?
- Coordination between regulators and supervisors.
- A legal framework that help to avoid fragmentation and the existence of blind spots.
- Policy actions towards high quality data on a comprehensive registry of household credit and debt.
- Prospective analysis of emerging risks in the traditional banking system that take into account indirect
exposures to the non-banking system.
- Adapt and/or develop methodologies and models to assess the spillover effect of non-bank lenders
in times of stress, as well as considering them in traditional stress test assessments.

Some context on OECD support to the use of CBM:
 A recent OECD document (De Crescenzio et al., 2015) emphasizes that mainly countries facing the "original sin" use CBM. Chile
is one of them. This issue is important because measures of the "original sin" come from Panizza's work, who will be part of the
panel (Eichengreen et al., 2002; Hausmann and Panizza, 2003).
 Based on the previous point, it is worth clarifying what kind of CBM are in place in Chile. In addition, does the fact that in Chile
almost all-international bond issuing is in foreign currency represents a constraint/vulnerability for the local financial system?
- Financial literacy and educational programs to support better decisions at the household level.
2. Background
In Chile, the current approach to deal with potential vulnerabilities associated to volatile capital flows can be
seen as orthodox, as we rely heavily on the importance of a flexible exchange rate regime and capital account
openness, in conjunction with a consistent monetary and fiscal policy framework, and a sound banking regulation
and supervision. However, it is important to remind to the public that we have come a long way.
In fact, nearly 40 years ago, Chile faced one of the world's costlier financial crises precisely because the lack of
several of these elements. In particular, FX exposures at a heavily leveraged and unsupervised banking sector
contributed to the spread of the banking crisis after the fixed exchange rate regime collapsed in the early 1980s.
As a result of this experience, banking regulation and supervision was substantially upgraded. In 1986, the
General Banking Law introduced limitations on currency mismatch, constraints on related party lending, and
restrictions for banks to receive goods instead of liquid resources; all of them, elements that were common
practice before the 1982 crisis.
Paradoxically, what could be considered harsher regulation did not hamper financial deepening. Instead, it
fostered solvency and credibility of the banking system and allowed its healthy development in the ensuing
decades. At the core of this development was the creation of a funded pension system, and subsequent capital
market reforms, together with capital market openness, which dramatically changed the size, composition, depth,
and strength of the financial sector in Chile.
Now, during the transition toward fully implementing the current policy framework, Chile experienced a period
of capital control that have been highly reviewed in the literature. The unremunerated reserve requirement
(URR) implemented in Chile during the 1990s helped to change the composition of capital flows toward longer
terms but was less effective in terms of reducing the aggregate level of capital flowing into the country.
After removing the URR completely by the end of the 90s and allowing the exchange rate to fluctuate freely,
the banking and corporate sector learned to operate in a completely different environment, characterized by
an extensive used of the derivative market. In In particular, corporations have learned to operate in a flexible FX
environment by using both, natural and market-based FX risk hedging instruments. This development has been
supported by the development of the derivatives market, in which Pension Funds have been key counterparts as
well. Banking regulation, in turn, have result in limited currency mismatches at the bank level, which have made
the introduction of new regulation to deal with FX risk unnecessary, as we have observed in many emerging
market economies after the Global Financial Crisis (GFC).
While may be true that other emerging economies have been increasingly active in the implementation of CBM
in their banking systems, in Chile, we have followed a different approach to deal with FX risk at the banking
level. This approach has been mainly characterized by limiting banks' direct FX-currency exposure (limited
currency mismatches) as part of our overall capital requirements for market risk purposes. Also, by acknowledging
the potential indirect FX risk through the credit provisioning requirements.
In fact, in Chile, the main regulatory changes introduced has been the recent modification of the General
Banking Law (GBL), which constitutes a major step forward for the local banking industry, in that it will contribute
to reducing the gap with international regulatory standards established under Basel III. The new regulatory
framework raises important challenges for the industry in terms of compliance with the new, more demanding
solvency requirements, especially for entities with a smaller capital cushion.
High-level Policy Seminar on Integration or Fragmentation? International Capital Flows in the Post-crisis World, September 2019
CENTRAL BANK OF CHILE
Monetary policy framework and its effectiveness
Buffers used during the years of slow growth 2014-2017 are being rebuilt
A New Banking Law is adopting the Basel III solvency standards and introducing a countercyclical capital buffer
Current Law
New Banking Act
0 - 4% Pillar 2 CBCh favourable opinion
0 - 2.5% CCyB CBCh lead
1 - 3.5% Systemic surcharge CBCh favourable opinion
10.5%
Conservation buffer
8%
Subordinated bonds
Subortdinated
+ additional provisions
6%
bonds
4.5%
Tier 1 Capital Tier 1 Capital
Sources: Central Bank of Chile.
High-level Policy Seminar on Integration or Fragmentation? International Capital Flows in the Post-crisis World, September 2019
CENTRAL BANK OF CHILE
The Chilean banking industry
Main changes in the Chilean banking industry
Change Concept Characteristics Advantages Challenges
New GBL New solvency Reduces gaps with Bank's capacity to comply with new
requirements (B3) international standards standards
Regulatory Revision of Changes if financial Greater importance to the Maintaining the quality and timelines of
environment Compendium of statement reporting financial statement; reduces financial information; measures for
Accounting requirements asymmetries in financial mitigating operational risk
Regulations statement reporting
Emerging risks Cybersecurity events Vulnerability of digital Mitigation strategies at the Greater investment cybersecurity
platforms; temporaray industry level
suspensión of services
Integration of retail Parent banks absorb Wider coverage of consolidated Incorporation of new debtors in credit risk
financing nonbank card issuers debtor information models
Expansion into Oversear bank Acquisition of Banks Diversification of business Different regulatory framework; large
new business subsidies overseas models overseas investment by local parent
areas banks
Source: Financial Stability Report, first half 2019, Central Bank of Chile.
Let me add one more thing regarding the use of CBM by several EMEs, which have targeted the banking system,
rather than the general resident-non-resident relationship, as is usually done by capital controls. The Figure
below, for example, based on De Crescenzio et al. (2015), shows that EMEs countries exposed to the original sin
(unable to borrow internationally in local currency) appear as tightening CBMs on banks' liabilities during the
2013-2015 period. Our understanding is that the databases used in cross-country analysis still contain a high
degree of self-judgement by reporting countries that sometimes affect the quality and consistency of the
information provided. At least this is our experience regarding answering the IMF's survey on exchange rate
arrangements and exchange restrictions (AREAER), which is used in the majority of cross-country comparison of
CBM and capital controls usage.
High-level Policy Seminar on Integration or Fragmentation? International Capital Flows in the Post-crisis World, September 2019
CENTRAL BANK OF CHILE
Currency-based measures
With the exception of China, only countries suffering from original sin used and
tightened CBMs on banks' FX liabilities
Tightening
No tightening
No Original Sin Original Sin
Source: De Crescenzio, Golini, and Ott (2015), "Currency-based Measures Targeting Banks - Balancing National Regulation of Risk and Financial Openness," OECD Working Papers on International Investment 2015/03.
Recent evidence on the evolution of capital controls shows that Chile has taken more liberalization actions than
tightening actions on both inflows and outflows (Pasricha et al., 2018). The following Figure shows the cumulated
weighted net inflow easing actions and weighted net outflow easing measures in Chile and in a group of EMEs
(excluding Chile).
Pasricha (2017) shows that policymakers use capital inflows tightening for macroprudential concerns, while use
capital outflows easing for competitive purposes. In Chile, the dynamic of outflows easing reflect mainly that
Pension Funds' limits on investing overseas have loosen. Nonetheless, Chile is among those EMEs that are less
active when it comes to capital control actions over the past decades. The challenge, however, still remains in
terms of addressing the actual level of capital account openness rather than it's tighten/loosen evolution.
High-level Policy Seminar on Integration or Fragmentation? International Capital Flows in the Post-crisis World, September 2019
CENTRAL BANK OF CHILE
Pasricha et al. (2015)
Indices of capital controls policy for Chile and other EMEs
Pasricha et al. (2015) indices of capital controls policy for Chile and other EMEs
Total number of policy actions: 1 Jan 2001 - 31 Dec 2015 (*)
(net easing)
baseline models include the 11 most active countries
300
Inflows Outflows
4.0 12 4.0 15
250
3.5 10 3.5
3.0 8 3.0 10 200
2.5 6 2.5
150
2.0 4 2.0 5
100
1.5 2 1.5
1.0 0 1.0 0
50
0.5 -2 0.5
0
0.0 -4 0.0 -5
CZE
EGY POL IDN CHL RUS COL PHL ZAF PER IND
BRA TUR THA ARG KOR CHN
MEX HUN MYS
MAR
01 03 05 07 09 11 13 15 01 03 05 07 09 11 13 15
(*) Blue bars are countries with fewer than 32 actions in sample. Red bars are those with at least 32 actions in sample. Red/blue shaded bars represent countries with more than 32 actions in sample but no inflow
targeting actions. Sources: Pasricha et al. (2015) and BIS.
Besides the Chilean approach to deal with FX risk at the banking level and the recent trend that has deepened
financial liberalization, the possibility to activate capital controls under extreme circumstances is still part of
our constitutional law. In Chile, we are under the process of simplifying our FX regulation, as well as improving
our Financial Market Infrastructures (FMIs), including the FX dimension to them. Thus, the Central Bank of Chile
is currently working to allow the clearing of USD denominated large-value payments through its Real Time Gross
Settlement payment system. Also, it is developing a Trade Repository for OTC derivatives, and it is about to issue
the regulation for FX clearinghouses. Finally, the onboarding of the Chilean Peso into the Continuous Linked
Settlement (CLS) System is a priority for the Central Bank of Chile. These measures may contribute to increasing
the likelihood of issuance of local currency bonds overseas.
Now, let me address some of the concern raised regarding new vulnerabilities, in particular at the non-banking
sector. A reasonable concern is to what extent the low level of FX-risk at the banking sector in Chile have pushed
for higher FX-risk in the non-banking sector? Our assessment is that the rising vulnerabilities observed in the
nonbanking sector can be associated to the stronger bank regulation, but it does not correspond to the evolution of
FX risk. In fact, the evolution of the non-banking sector reflects mainly issues of information asymmetries and the
fact that some of these institutions can take advantage of payroll direct charges to enhance their consumer credit
business.
While non-bank lenders (NBL) provide commercial loans, their main business is to lend to households in the
form of consumer and mortgage loans. In the consumer portfolio, NBLs include retailers, family compensation
funds (CCAF), savings and loan associations (S&Ls), factoring and leasing companies (F&Ls), and car dealerships.
The mortgage portfolio includes endorsable mortgage loans ("mutuos hipotecarios") issued by banks and mutual
societies included among the assets held by life insurance companies (LICs). Finally, factoring and leasing
companies mainly provide trade credit to businesses. Therefore most, if not all, of the lending activities of this
sector is done in local currency.
Having said that, we monitor this sector carefully, since the household debt issued by NBLs has increased a
share of total consumer debt. Nonbank loans had a real annual growth rate of 11.5% in the fourth quarter of
2018. The contribution of debt with retailers was 4.5%; car dealership, 3.9%; CCAFs and F&Ls,1.2%; and S&Ls,
0.8%. In the same period, bank consumer loans grew around 5.7%. Nonbank consumer loans together were
equivalent to about 58% of total bank consumer loans. This rate has been stable since 2012, although the
composition has changed. Specifically, the share of retailers has been steadily increasing since mid-2013, while
the share of companies oriented toward car financing has expanded more recently. As of December 2018, retailers
accounted for 24.3%; car dealership, 12.1%; CCAFs, 12.1%; S&Ls, 6.6%; and F&Ls, 2.8%.
High-level Policy Seminar on Integration or Fragmentation? International Capital Flows in the Post-crisis World, September 2019
CENTRAL BANK OF CHILE
Non-bank lenders
Household debt issued by NBLs has increased as a share of total consumer debt
Real annual growth of loans Nonbank credit (*)
(real annual change, percent) (percent of bank consumer loans)
15
Retailers Car dealerships F&Ls
60 Retailers Car dealerships F&Ls CCAFs S&Ls
CCAFs S&Ls Bank
13
NBLs
50
11
9
40
7
5
30
3
20
1
-1
10
-3
-5 0
13 14 15 16 17 18 13 14 15 16 17 18
(*) Based on individual financial statements, including for bank consumer credit, which is used as the denominator. Source: Central Bank of Chile based on data from the SBIF, CMF and Suseso.
The steady growth of the nonbank portfolio is a potential source of vulnerability, given that most of these
lenders are outside the consolidated debt perimeter. In terms of arrears in the nonbank consumer portfolio,
retailers recorded a slight improvement relative to end-2018, to 3.8%. In contrast, for the CCAFs, delinquency has
increased steadily since 2013-when they began to use accounting criteria more similar to the banks-and it is
currently more than double the rates for the rest of the nonbank consumer lenders.
Moreover, the banking sector has significant exposure to the NBLs, through commercial loans to these
institutions. In particular, loans to this segment have increased among medium-sized banks in recent years.
Thus, the exposure-to NBL debt-of the large and medium-sized banks, as of February 2019, represented 12.7
and 27.2% of their regulatory capital, respectively. The profitability of the NBLs, measured through ROA, has been
relatively stable, standing at 4.6% at year-end 2018 for retailers; 3.8% for S&Ls; and 2.6% for factoring, leasing,
and car dealership (FL&A) together. In the case of the CCAFs, ROA has increased in the last two years. The leverage
ratio, in turn, is highest for the FL&A group, and it increased for the retailers in 2018.
High-level Policy Seminar on Integration or Fragmentation? International Capital Flows in the Post-crisis World, September 2019
CENTRAL BANK OF CHILE
Non-bank lenders
In terms of arrears, CCAFs is the only component consistently increasing its
delinquency rate affecting its profitability measured through ROA
Arrears of 90 to 180 days (1) Exposure to the consumer segment (2)
ROA and leverage ratio (3)
(percent of loans) (percent of system assets)
(percent of bank consumer loans)
12
12
Retailers CCAFs
Direct Retailers FL&A CCAFs S&Ls
2015 2016 2017 2018
S&Ls F6Ls
10
10
ROA
Car dealerships
Retailers 4.7 4.9 4.8 4.6
FL&A 3.3 3.2 2.6 2.6
8
8
CCAFs -0.1 0.9 1.6 2.3
S&Ls 2.2 2.7 3.8 3.8
6
6
Leverage ratio
Retailers 33.4 32.2 30.8 22.2
4
4 FL&A 21.1 20.5 17.2 16.5
CCAFs 34.5 36.9 37.7 36.9
S&Ls 32.1 29.1 28.2 27.2
2
2
0
0
13 14 15 16 17 18
13 14 15 16 17 18
(1) Data through December 2018, except for retailer, which are through September 2018. F&Ls include arrears on factoring and leasing. Arrears are 90 to 180 days, except for CCAFs. (2) Indirect exposure includes
retailers, FL&A, CCAFs, and S&Ls. FL&A combines factoring and leasing companies and car dealership. (3) ROA is calculated as earning over assets; the leverage ratio as equity over assets. Source: Central Bank of Chile
based on data from the SBIF; CMF; and Suseso.
Now, regarding potential trade-offs associated to the Chilean regulatory framework: Has the Chilean regulatory
framework in place be repressive? The evidence shows that Chile's banking strength have not undermine its
financial development under different perspectives. The Chilean financial system has evolved significantly in
recent decades, and its contribution has been key in the economic development of the country and the
construction of a more prosperous, healthy and modern economy.
Today, the Chilean financial sector is one of the most developed in the emerging world. In five decades, it has
gone from being almost exclusively made up of traditional banks, to include several other market participants,
such as Pension Funds, General Fund Administrators and Insurance Companies, among others. The Chilean
financial system relatively outperforms with respect to other comparable countries in dimensions such as market
capitalization, number of branches per inhabitant, and participation in domestic credit. On the other hand, the
banking system in particular is positioned among the strongest in the reference group of emerging countries
according to comparable international assessments.
High-level Policy Seminar on Integration or Fragmentation? International Capital Flows in the Post-crisis World, September 2019
CENTRAL BANK OF CHILE
Banking sector
The Banking sector in Chile looks solid
Bank Financial Strength Index Chilean financial development (*)
(percent, Moody's weighted average long-term banks rating) (relative percent)
ROA
Saudi Arabia Banking sector
100
Chile
China 75
Malaysia
50
Poland
CAR ROE
Mexico
25
Peru
Thailand 0
Indonesia
Philippines
Colombia
Uruguay
Panama
Cap./Assets 1-NPL/L
South Africa
India
Market Cap
Financial sector
Romania
100
Hungary
Paraguay
75
Bulgaria
50
Russia
1/CDS Branches
Brazil
25
Turkey
Vietnam 0
Nigeria
Argentina
Ghana
Egypt
Domestic
Ukraine
Derivatives
credit
0 2 4 6 8 10 12 14 16 18
LAC EME OECD Chile
(*) Data are relative to the maximum on each dimension at the end of 2016 or to the latest availability. Sources: Moody's and Central Bank of Chile based on information from BIS, WB, IMF and Bloomberg.
Over time, markets have developed adequate FX hedging mechanisms having lower currency mismatches,
inflation expectations have become firmly anchored at the monetary policy target level, the CBC has overcome
fear of floating and the economy exhibit one of the lowest FX pass-through to domestic prices, financial markets
have deepened and the labor market has gained some flexibility. As the Chilean economy is not immune to
external shocks, the ability to cushion them through FX and countercyclical policy response has improved
significantly.
High-level Policy Seminar on Integration or Fragmentation? International Capital Flows in the Post-crisis World, September 2019
CENTRAL BANK OF CHILE
Monetary policy framework and its effectiveness
the ERPT is one of the lowest in LATAM, the corporate sector shows a contended currency
mismatch, and inflation expectations have remained anchored throughout the IT period,
Currency mismatch over 10% in the
Exchange-rate pass-through compared Actual and expected inflation indicators
(percentage) corporate sector (*) (percentage)
(percent of total assets)
0.7
40 10
ERPT-Headline ERPT-Core
Imported Comp.
0.6
8
0.5
30
6
0.4
4
0.3
20
2
0.2
0
0.1
10
Inflation (headline)
-2
0.0
Inflation (core)
Ec.
Inflation expectations (11-month ahead)
Asia Rica
Peru
Chile
Brazil
Bolivia
LATAM Europe -4 Inflation expectations (23-month ahead)
Mexico 0
Adv. Panama
Uruguay
Colombia LATAM-5 Paraguay
Eme. Argentina
Costa
01 03 05 07 09 11 13 15 17
01 04 07 10 13 16 18.I
Eme.
(*) Based on a sample of firms that report their balance sheet in pesos. Currency mismatch is the difference between foreign currency liabilities and foreign currency assets, less the net position in derivatives (the difference
between buy and sell positions in derivatives contracts). Sources: WB, IMF, BIS and Central Bank of Chile, based on data from Financial Markets Commission; IMF REO Western Hemisphere, 2016.
Regarding the risk at the public sector, in normal times the fiscal space is determined by the fiscal rule and
public indebtedness. Fiscal policy in Chile is based on a structural (cyclically-adjusted) balance rule adopted in
2000, but after seven years of strict compliance of a 1% surplus target, a tacit escape clause was called at the time
of the GFC, raising the structural deficit from 0.5% of GDP to 3.1%. Despite fast economic normalization
afterwards, the actual structural balance never returned to pre-crisis levels and even softened targets were
frequently not met in the ensuing 10 years. It is currently conducted based on an explicit commitment of the fiscal
authority to attain a previously defined target. However, during times of crisis and periods of emergency Chile's
experience suggests that the space of fiscal policy is limited. In fact, the fiscal impulse of 2009 generated a fiscal
deterioration that is still under consolidation. Nonetheless, in the current juncture, the Chilean economy appears
to be prepared to face external shocks, but with some gaps to be filled in the fiscal front. For these reasons,
several measures are being taken to achieve fiscal consolidation. Among others: (i) a gradual path to reduce
structural deficit by 0.2% of GDP per year, to 2022, (ii) first step above target: structural deficit reduced 0.5% of
GDP, (iii) a Debt/GDP ratio currently at 24% should level off in the next two years, (iv) Fiscal Council given
independent status, (v) preferential regime for defense spending in course of reform, and (vi) fiscal sustainability
a central concern in discussion of tax and pension reforms. Not all emerging economies are equally prepared to
react, and Chile is relatively well positioned when compared to other emerging economies.
In order to deal with the undesired effects of volatile capital inflows, several EMEs have implemented different
policies to deal with the appreciation/depreciation cycle and credit booms (e.g reserve requirements, FX
intervention, capital controls). There is substantial evidence that capital flows to EMEs are volatile and that in
part depend on "push" factors that are unrelated to the marginal productivity of the host economy. Volatile
(boom-bust-cycle) capital inflows are a significant concern for policymakers. The surge of capital flows is usually
associated with booms in asset prices, appreciation, credit booms, and increasing current account deficits. While
the sudden stop is associated with asset prices adjustment and financial distress.
In Chile, free floating and FX volatility has helped reduce incentives for arbitrage and carry trade. Besides, the
exchange rate flexibility facilitates asset price adjustment. Providing the right incentives for resident investors
(pension funds and the government) to counteract the non-residents behavior, smoothing net capital flows!
Nonetheless, sectorial mismatches in banks, non-banks, and households, still need to be monitored. In Chile, as
mentioned above, these mismatches are limited due to FX hedging and regulation.
The CBC was an early adopter of an inflation-targeting regime, shortly after its independence granted in 1989.
A fully floating FX regime was adopted in September 1999 and capital controls where abolished in a necessary
step to complete a coherent framework to effectively control inflation. Since then, the Central Bank has kept its
commitment of no intervention in the FX market, except when required by extraordinary circumstances.
High-level Policy Seminar on Integration or Fragmentation? International Capital Flows in the Post-crisis World, September 2019
CENTRAL BANK OF CHILE
Monetary policy framework and its effectiveness
The Chilean experience with capital controls and FX interventions
FX rate and capital controls: 1990-2018 (*) International reserves and FX interventions: 1982-2017
(CLP per USD) (millions of USD)
800 45000
Capital controls
40000
FX interventions
FX bands
700
35000
600 30000
25000
500
20000
400 15000
Reserves requirements to the foreign loan and
later extended it to capital flows not related to
10000
Free floating
debt, the American certificates of deposit of
300
foreign shares, and potentially speculative FDI.
5000
Increased the discount rate.
200
0
90 92 94 96 98 00 02 04 06 08 10 12 14 16 18
82 85 88 91 94 97 00 03 06 09 12 15 18
(*) Foreign exchange rate defined as CLP per USD. Sources: Central Bank of Chile and De Gregorio, J., S. Edwards, and R. Valdés (2001), "Controls on Capital Inflows: Do they Work?" NBER WP 7645.
All these elements allow monetary policy to operate as a first defense mechanism against external shocks in
normal times. Besides monetary policy, the CBC has a financial stability mandate. Such mandate should be
pursued by a combination of regulation, information, and macroprudential management. In particular, monetary
policy tools should be used primarily to achieve the price stability mandate, and only as a last resort to deal with
financial instability. The free-floating FX regime is perfectly consistent with achieving both mandates (price and
financial stability), as (i) the inflation targeting regime is highly credible, and (ii) the corporate sector is well hedged
against exchange rate volatility.
High-level Policy Seminar on Integration or Fragmentation? International Capital Flows in the Post-crisis World, September 2019
CENTRAL BANK OF CHILE
Monetary policy framework and its effectiveness
Institutional investors provide a natural base for financial market deepening and
market-based FX-risk coverage instruments
Main financial assets holders (*) Derivatives market activity
(percent) (annual transactions, percent of GDP)
100
7
1998 2001 2004 2007 2010 2013 2016
90
6
80
70
5
60
50
4
40
30
3
20
10 2
0
1
2008 2018 2008 2018 2008 2018 2008 2018 2008 2018
Bank Bds. Sov. Bds. Corp. Bds. Term-dep Stocks
0
Emerging Economies Latin American Economies Chile
Pension funds Mutual funds Insurance Co. Other
(*) Other includes other investment funds, stock exchanges, and stock brokers. Source: Central Bank of Chile, based on data from the Superintendence of Pensions, CMF and Santiago Stock Exchange.
The ability to overcome the fear of floating was helped with the buildup of capacities for companies and
financial intermediaries to manage the risks associated to a more volatile FX. Consequently, derivatives markets
were deepened as well as institutional investors provided a natural base for financial market deepening and
market-based FX-risk coverage instruments. The Chilean financial market has transited from being largely
dominated by traditional banking to being composed by several other market participants, including Pension
Funds, General Fund Administrators and Insurance Companies; among others. Assets under management of these
non-bank investors went from less than 1% of GDP in 1984, to 65% in 2000, and to almost 100% of GDP in 2018.
Currently, around 85% of total domestic corporate bonds and around 65% of sovereign bonds are held by
institutional investors, as a result of which reliance on banking credit of these corporations has gone from 91% of
financial debt in 1986 to around 25% in the recent years.
High-level Policy Seminar on Integration or Fragmentation? International Capital Flows in the Post-crisis World, September 2019
CENTRAL BANK OF CHILE
Monetary policy framework and its effectiveness
Monetary policy is strongly supported by the free-floating FX regime
10Y interest rate and FX volatility (*) Currency implied volatility 1-month EE
(sample: 2017-2018) (percent)
30
FX
0.14
Median
Brazil
20
Egypt
0.12 Nigeria
Turkey
10
0.10
change)
0
Romania
0.08
Jan.10 Jan.12 Jan.14 Jan.16 Jan.18
Philippines
(weekly
Bulgaria
South Africa
Colombia 10Y rates volatility 1-month EE
0.06
Indonesia
rate
India 10-y rate
(percent)
0.6
Median
Mexico
Hungary
Croatia
0.04
Peru
Vietnam
interest
0.4
Russia
0.02
Poland
Thailand
Malaysia 0.2
10-year China Chile
0.00
0.0 0.5 1.0 1.5
0.0
Exchange rate (weekly percentage change)
Jan.10 Jan.12 Jan.14 Jan.16 Jan.18
(*) Red points correspond to economies with free-floating FX regime according to IMF classification (Annual Report on Exchange Rate Arrangements and Exchange Restrictions, 2017). Source: IMF and Bloomberg.
This framework has basically remained in place for almost two decades and its effectiveness has improved as
markets, agents and institutions have adapted to it. The learning and effectiveness of the framework can be
understood not only with the expectations anchored to the target, but also in the low volatility of interest rates
in exchange for a (covered) higher FX volatility.
High-level Policy Seminar on Integration or Fragmentation? International Capital Flows in the Post-crisis World, September 2019
CENTRAL BANK OF CHILE
Monetary policy framework and its effectiveness
Overall, the Chilean economy appears to be best prepared to face external shocks than before
the GFC, except on the fiscal front
FX misalignment (2)
Pension funds (3)
Cap. Adequacy Index
International reserves (5)
Gross public debt (3)
Inflation deviation to
target (4)
2007-2008 a