An Analysis of the 2002 Uruguayan Banking Crisis. Luis de la Plaza Sophie Sirtaine. World Bank Policy Research Working Paper 3780, December

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Public Disclosure Authorized WPS3780 Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized An Analysis of the 2002 Uruguayan Banking Crisis Luis de la Plaza Sophie Sirtaine
Public Disclosure Authorized WPS3780 Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized An Analysis of the 2002 Uruguayan Banking Crisis Luis de la Plaza Sophie Sirtaine World Bank Policy Research Working Paper 3780, December 2005 The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the view of the World Bank, its Executive Directors, or the countries they represent. Policy Research Working Papers are available online at The authors are inmensely grateful to Aquiles Almansi, Mariluz Cortes, Augusto de la Torre, Juan Gaviria, Daniel Oks, John Pollner and Axel van Trotsenburg, for the very helpful comments given to previous versions of this paper. ABSTRACT This paper reviews the series of events that led to the 2002 Uruguayan banking crisis, assesses the current status of the Uruguayan banking sector, and analyzes the policy responses undertaken by the Uruguayan authorities to counteract the crisis. The main conclusion from this analysis is that although the immediate trigger for the crisis was caused by contagion resulting from Argentina s financial crisis, the spread and magnification of the crisis that engulfed the Uruguayan economy was amplified by certain weaknesses of the Uruguayan economy in general, and the domestic banking sector in particular. The authors also believe that the policy responses adopted by the Uruguayan authorities were mostly adequate, allowing Uruguay to successfully counteract simultaneous banking and public debt crises. Most importantly, the Uruguayan authorities were able to overcome a severe crisis while preserving the necessary trust in banking contracts, achieving a high level of social stability and political cohesion, and maintaining a fluid dialogue with multilateral financial institutions and all affected parties. The cooperative and consensual approach taken by the authorities created the necessary conditions to overcome some of the important obstacles to the recovery of the domestic banking sector. The paper is organized in three sections: (i) (ii) (iii) Section 1 follows the chronology of events before, during and after the crisis, and reviews the policy responses undertaken by the Uruguayan authorities assisted by multilateral institutions to counteract and stem the crisis; Section 2 assesses the current status (as of June 2004) of the Uruguayan banking sector, its immediate prospects and the remaining areas of weakness; and Section 3 attempts to draw useful policy lessons derived from the actions undertaken by the Uruguayan government. 2 Table of Contents SECTION I: THE URUGUAYAN BANKING CRISIS... 4 Situation prior to the crisis... 4 Description of the Crisis... 8 First Wave of Policy Responses: Crisis Management Second Wave of Policy Responses: Recovery from the Crisis Restructuring of the Banking System Strengthening the Regulatory and Supervisory Frameworks Debt Rescheduling SECTION II: THE URUGUAYAN BANKING SECTOR: CURRENT STATUS Current Situation...20 Challenges SECTION III: POLICY CONCLUSIONS AND LESSONS LEARNED Levels of and Banking Exposure to Government Debt Dollarization and Contagion Government s Debt Restructuring Institutional Stability...27 Relations with International Financial Institutions Exchange Rate Dynamics Costs of the Crisis Specific Banking Measures Preservation of Banking Contracts and the Payment System Internalization of currency mismatch Early Bank Intervention Targeted Policies Toward the Private Banks Conclusions Bibliography SECTION I: THE URUGUAYAN BANKING CRISIS Situation prior to the crisis At the end of 2001, the Uruguayan banking sector was considered by most to be reasonably healthy. Although a protracted economic recession that started in 1999 had weakened the profitability of Uruguayan banks particularly the public banks, the system was perceived to be, with some exceptions, properly capitalized, to have adequate liquidity and contrary to many other Latin American countries to lack a large exposure to the public sector. The system was highly segmented into two large public banks (Banco de la República Oriental del Uruguay, or BROU and Banco Hipotecario del Uruguay, or BHU, together accounting for 40 percent of the system s assets) and a group of approximately 30 private mostly foreign banks, that also included some local investment banks and savings & loans cooperatives. Among these, Banco Galicia Uruguay (BGU) and Banco Comercial (BC) clearly dominated the segment, with combined assets representing approximately 20 percent of the overall banking system. Uruguay: Selected Banking Indicators As of December 31, 2001 (%) Total Public Banks Private Banks Asset Quality NPLs/Total Loans Provisions/NPLs Capital Adequacy Assets/Capital Capital/Risk Adjusted Assets * Profitability R.O.A. (after tax) R.O.E. (after tax) Liquidity Loans/Deposits Liquid Assets/Deposits Memorandum Total Assets (share) FX Deposits/Total Deposits FX Loans/Total Loans * This number includes ratios for two intervened bankrupt banks, Banco de Crédito and Caja Obrera. Source: Banco Central del Uruguay and IMF s estimates Notwithstanding the overall picture of relative soundness, the system was, however, intrinsically vulnerable to external shocks due to its deposit structure, which was highly dollarized and with a large presence of non-resident depositors. In fact, as of December 2001, total deposits in the system amounted to US$15.4 billion (representing 83 percent of Uruguay s 2001 GDP), of which 90 percent were foreign currency deposits, with 47 percent of these deposits being held by non-residents. Despite this skewed deposit structure, however, the Uruguayan Central Bank (Banco Central del Uruguay, or BCU) lacked specific prudential regulations regarding foreign currency denominated deposits 4 held by non-residents, there were no specific liquidity requirements or limitations on such deposits, and supervision of the state-owned banks was generally weak and untimely 1. Total Deposits by Currency US Dollar Deposits by Nationality of Depositor Foreign Currency 90% Local Currency 10% Non- Residents 47% Residents 53% Source: BCU and IMF, as of December 31 st, 2001 Dollarization was not limited to the banks liabilities, but extended also to their asset side. As of the end of 2001, total loan book for the system amounted to US$11.5 billion, out of which US$8.6 billion (or 75 percent) was denominated in foreign currency, mainly in US dollars. Paradoxically, US$6.1 billion (or 71 percent) of these loans had been extended to residents, even though the vast majority of them did not earn revenues in any foreign currency. Within the system, the financial condition of the two largest public banks (BROU and BHU) was very weak. These two banks had questionable lending practices and weak corporate governance and, as a consequence, their level of non-performing loans was greater than that of the rest of the system, their costs higher and their profits lower. In fact, as of December 2001, the ratio of non-performing loans to total loans for the public banks was 39.1 percent, versus 5.6 percent for the private banks, while after tax return on equity was minus 4.5 percent for the public banks, versus minus 0.9 percent for the private banks. Particularly vulnerable was the case of the BHU, which as of the end of 2001 represented approximately 10 percent of total deposits within the system. This institution, the country s almost exclusive provider of mortgage lending, was especially susceptible to external shocks, given the substantial currency and maturity mismatch in its balance sheet. In fact, the majority of the BHU s deposits (77 percent) was denominated in US dollars and had relatively short maturities, while the greater part of its loans (94 percent) were pesodenominated, long-maturity loans extended to peso-earners. 1 Third Review under the Stand-By Arrangement and Request for Modification and Waiver of Applicability of Performance Criteria, Supplementary Information, IMF, June 2003, page 2. 5 On the fiscal front, the protracted economic recession that started in 1999 had led the government to accumulate increasingly large deficits (from 38 percent of GDP in 1998 to 58 percent by 2001) that were financed through correspondingly sizeable levels of public debt, the vast majority of which was financed via external issuance of foreign currency denominated debt. Thus, just before the crisis erupted, total public sector debt amounted to US$10.7 billion, out of which 83 percent was denominated in foreign currencies. Cyclicality of Uruguay's Government Debt Total Government Debt as % of GDP (Left) GDP Growth (annual %) (Right) 140% 120% 100% 80% 60% 40% 20% Crisis Starts 10% 5% 0% -5% -10% 0% -15% Source: Global Development Statistics This high level of government debt as a percentage of GDP represented the highest recorded level since the mid 1980 s when Uruguay also experienced severe GDP contractions and, unfortunately, preceded the eruption of the Argentinean crisis 2. This reality, combined with the fact that most of the government debt was denominated in foreign currencies, made Uruguay highly vulnerable to an external shock of the nature and magnitude of the Argentine crisis. The external debt situation would, as we will see, only worsen with the crisis, with total external debt reaching US$11.3 billion by December 2002 (or 93 percent of that year s GDP) and US$12.1 billion by December 2003 (or 108% percent of that year s GDP). 2 Uruguay s level of public debt as a percentage of GDP in 2001 (i.e. 58 percent) compares unfavorably versus, for instance, 51 percent for Argentina that same year and 44 percent for Brazil in Partially responsible for the weak performance of the Uruguayan economy since 1999 was the one-two punch inflicted by the successive devaluations of the Brazilian Real and the Argentinean Peso in 1999 and 2001 respectively. In fact, the loss of competitiveness caused by the considerable appreciation that the Uruguayan Peso s real exchange rate experienced as a consequence of Brazil s crisis in 1999 was only to be made worse by Argentina s devaluation in late Thus, by January 2002, and as can be seen in the chart below, the Uruguayan Peso was seriously out of equilibrium not only against Uruguay s two major trading partners, but also vis-à-vis the rest of the world Uruguay: Real Exchange Rate (1995=100) vs. Argentina vs. Brazil vs. Rest of the World Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Source: BCU In summary, at the end of 2001, the Uruguayan economy was characterized by the weakness of the public banks, its high level of foreign currency indebtedness both private and public and the sluggishness of the economy derived from an appreciated real exchange rate against major trading partners. Under these circumstances, the Uruguayan banking sector was highly vulnerable to an external shock and potential currency devaluation. 7 Description of the Crisis The crisis erupted in December 2001 when the Argentine government imposed capital controls and deposit freezes to Argentina s nationals (popularly known as the corralito ). At that time, the two largest private banks in Uruguay (Banco Galicia Uruguay, or BGU; and Banco Comercial, or BC) began facing liquidity problems as a result of their high level of exposure to Argentina. In fact, these two banks which combined represented approximately 20 percent of total deposits within the system were both owned by Argentinean financial groups and were, therefore, highly susceptible to Argentina s economic turmoil. The case of BGU is particularly worth noting since its demise has been considered by many as the event that truly triggered the wider crisis. BGU was a subsidiary 3 of Banco de Galicia Argentina s largest private bank and was, as of December 2001, the second largest Uruguayan bank in terms of assets. BGU s vulnerability stemmed from its business model, which was concentrated almost exclusively in taking deposits from Argentine nationals and corporations and lending those same funds also to Argentine nationals and corporations. Therefore, when the Argentine government imposed capital controls and deposit freezes, BGU was severely affected as access to its assets in Argentina was drastically curtailed and as cash-strapped Argentineans begun withdrawing their deposits from Uruguay. As a consequence, during the month of January 2002 alone, BGU lost an estimated 15 percent of total deposits, completely exhausting its available liquidity. Faced with this situation, the Uruguayan central bank had no choice but, on February 13, 2002, to temporarily halt BGU s operations and intervene the bank and, subsequently, to permanently suspend it. Similarly, BC, which as of December 2001 was the largest private bank in Uruguay, was also highly exposed to the Argentine economy due to its large holdings of Argentine government debt as well as its extensive lending to the Argentina conglomerate Grupo Banco General de Negocios, of which BC was part. Thus, as in the case of BGU, BC was confronted in early 2002 with severe liquidity constraints, with the situation being exacerbated by accusations of management fraud. After several attempts to re-capitalize the bank, the BC was also intervened by the BCU and subsequently restructured (please see below). Over the following weeks, and as the economic crisis deepened in Argentina, deposit withdrawals gradually continued and, by March 2002, 12 percent of total bank deposits mostly from non-residents had left the country. Although the authorities were expedient in providing liquidity support to the affected banks and a financial support program from the IMF was announced, negative public perception of the unfolding crisis continued exerting pressure on the Uruguayan currency, which the government attempted to counteract by introducing greater exchange rate flexibility and widening the existing crawling exchange rate band from 6 to 12 percent. 3 Although the BGU is often referred to as a branch of Banco de Galicia, in reality it had obtained a full banking license and should, therefore, had been considered as an Uruguayan banking institution (Authors Note) 8 Chronology of the Uruguayan Banking Crisis 3-Dec-01 Argentina establishes the Corralito 12-Dec-01 IMF suspends loan disbursements to Argentina 23-Dec-01 Argentina defaults 15-Jan-01 Uruguay widens its Crawling Exchange Rate Band 3-Feb-02 Argentina establishes the Corralón 13-Feb-02 Banco Central del Uruguay suspends operations of Banco Galicia-Uruguay 15-Feb-02 Uruguay losses investment grade rating 28-Mar-02 First attempts to re-capitalize Banco Comercial 31-Mar-02 Cumulative 12.2% of total deposits have been withdrawn since January 1st, Jun-02 Banco Montevideo-Caja Obrera is intervened 30-Jul-02 Bank holiday is declared 31-Jul-02 Cumulative 37.6% of total deposits have been withdrawn since January 1st, Jul-02 Banco Central del Uruguay has lost 79% of international reserves since January 1st, Aug-02 Bank holiday is lifted after a substantial bailout package provided by multilaterals As the financial crisis in Argentina worsened and deposit freezes were tightened (the corralón ), a second wave of deposit withdrawals ensued in April 2002, following Uruguay s downgrade from investment grade status and amidst mounting concerns that Uruguay would be forced to follow in Argentina s footsteps and impose itself deposit freezes. Thus, by May 2002, an additional 18 percent of deposits had been withdrawn from the system. Most importantly, by that date, deposit withdrawals were no longer confined to non-resident deposits and a few specific institutions, but had spread to include also resident deposits withdrawing their funds from the public banks 4. Evolution of Deposits (US$ millions) Dec-01 Mar-02 Jun-02 Sep-02 Dec-02 Total Deposits 15,403 13,475 10,744 8,007 8,374 Foreign Currency 13,970 12,261 9,824 7,458 7,747 Residents 7,413 6,953 5,958 5,250 5,431 Non-residents 6,557 5,308 3,866 2,208 2,315 Local Currency 1,433 1, Source: Banco Central del Uruguay As deposit withdrawals accelerated during May and June 2002, the authorities continued to actively provide widespread liquidity support to both private and public banks. Despite this continued support, on June 21, 2002, the third largest private bank, the Banco de Montevideo-Caja Obrera, run into severe liquidity shortages and had to be intervened by the authorities, which took over its operations and replaced its management. 4 The Uruguayan banking system prior to the crisis did not distinguish between resident and non-resident deposits. Although special entities (Cajas Bancarias) had been created specifically to service the non-resident segment of the banking system, the initiative had failed to catch on due to adverse fiscal consequences vis-àvis local banking institutions. Therefore, resident and non-resident deposits were mixed up within the system and, in some cases (e.g. Banco Galicia Uruguay) clearly dominated the deposit base of some institutions. 9 Peso/US$ Exchange Rate and Evolution of US$ Reserves (January to December 2002) Official International Reserves (Left Axis) 3,000 Exchange Rate (Right Axis) 30 2,500 USD mm. 2,000 1, Peso/USD 1, Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 10 Source: BCU The tilting point came in early July, when following a further deterioration of market sentiment that translated into widening government s bonds spreads the run on dollar deposits extended also to affect local currency deposits, causing, by late July, the position of the BCU to become untenable. After months of widespread deposits withdrawals and substantial liquidity support to the banking system, the level of available international reserves reached the critically low level of US$650 million (versus USD3.1 billion in December 2001, or an 80 percent decline). This low level of reserves was clearly insufficient to service the mounting external debt and to continue backing the large proportion of foreign currency denominated deposits still present within the system (i.e. US$8.7 billion as of July 2002). Confronted with this situation, the authorities opted to freely float the peso which immediately depreciated by 27 percent compelling the government to declare a five-day bank holiday on July 30, Evolution of Official International Reserves and Deposits Official International Reserves (Left Axis) Encajes at the BCU on USD Deposits and Local Currency Deposits (Left Axis) US$ Deposits (Right Axis) USD mm. 3,500 16,000 3,000 14,000 2,500 12,000 10,000 2,000 8,000 1,500 6,000 1,000 4, , Dec-00 Jun-01 Dec-01 Jun-02 Dec-02 Jun-03 Dec-03 Jun-04 USD mm. Source: BCU 10 As the crisis was unfolding during 2002, the drastic and sustained deposit withdrawals translated into a system-wide credit crunch, as banks both private and public scrambled to find any available liquidity by suspending new loans as well as by requesting early repayment of existing loans. Thus, credit to the non-financial sector shrunk by 37 percent during 2002 alone, greatly contributing to a GDP contraction of 10.7 percent for that same year. Evolution of Deposits and Credit to the Non-Financial Sector (December 2001 to December 2002) Credit to Non-Financial Sector Total Deposits US$ mm. 15,000 14,000 13,000 12,000 11,000 10,000 9,000 8,000 7,000 Dec-01 Mar-02 Jun-02 Sep-02 Dec-02 Source: Banco Central del Uruguay By the end of July 2002, a cumulative and staggering 38 percent of total deposits had been withdrawn from the system. In addition, with the peso havin
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