The Chilean economy was closed to international trade and capital flows, interest rates were regulated, credit was restricted, and banking activity was largely controlled by the State. In the second half of the 1970s the banking sector was privatized and liberalized. However, this was not accompanied by adequate regulation and supervision; and a relatively small financial system built major vulnerabilities. When macro policy missteps and external shocks hit in 1982, the banking sector was not just a weak link, but amplified them into the deepest economic and financial crisis in a generation. The Chilean financial crisis of the 1980s and the origins of the subordinated debt Financial crises are abrupt, costly and protracted affairs, and the Chilean financial crisis of the early eighties was no exception. This crisis is often quoted as one of the top 25 most severe financial crises in modern history. In 1981, annual output growth went from positive 9% in the first quarter,   I thank the comments and suggestions in preparing this speech to Solange Berstein and Mauricio Calani. Page 1 of 5  Central Bank of Chile March 2019  to 0% in the fourth quarter, and to minus 14% in 1982. That same year, unemployment reached a record of 25%, and businesses all over the country were seriously hampered, ultimately affecting their payment compliance. Banking profitability went quickly to negative territory and the delinquency rate quadrupled to 15% of the total portfolio, putting several banks solvency and operations at risk.

Intermediaries contribute to link both sides and bridge gaps of incentive and information frictions, by managing credit risk, liquidity risk and transforming maturities; thus contributing to a better resource allocation and fostering growth. Proper regulation, with a sound balance of risks assessment, can help prevent unsustainable and irresponsible credit growth, reducing the probability of insolvency while allowing banking institutions develop profitable businesses. So, it is not a question on whether or not to regulate, but rather how much to regulate, and how to do it without impairing efficient allocation of resources. Regulation has not been an obstacle to financial development in Chile in the 35 years since the debt crisis. Chilean capital markets—broadly defined—evolved in tandem with economic growth. The 1986 Banking Law was key in fostering this process, but it was hardly the only piece of the financial architecture that changed significantly. Notably, the creation of a defined contribution pension system, and subsequent capital market reforms, together with capital market openness, have dramatically changed the size, composition, depth, and strength of the financial sector in Chile. By funneling household savings into capital markets, Pension Funds were especially important to the early development of a deep debt market; and their contribution to market-making benefited from a stable macroeconomic environment with controlled inflation, extensive use of the UF, and the restructuring of Central Bank’s debt into longer maturities. A deeper and more liquid debt market also facilitated the pricing of debt issued by private companies in local markets.