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Minsky, Financial Governance, Banking,
and Financial Instability in Brazil
FELIPE REZENDE, PH.D.
, R e s e a r c h S c h o l a r
R e m a r k s P r e p a r e d F o r T h e C o n f e r e n c e :
“ F i n a n c i a l G o v e r n a n c e A f t e r T h e C r i s i s ” c o s p o n s o r e d B y T h e L e v y E c o n o m i c s I n s t i t u t e O f
B a r d C o l l e g e A n d M I N D S – M u l t i d i s c i p l i n a r y I n s t i t u t e F o r D e v e l o p m e n t A n d S t r a t e g i e s , W i t h
S u p p o r t F r o m T h e F o r d F o u n d a t i o n
E v e r e s t R i o H o t e l R i o D e J a n e i r o , B r a z i l
S e p t e m b e r 2 6 – 2 7 , 2 0 1 3
, NY, USA
MINDS
The conference in Rio de Janeiro also represents the beginning of a multi-year grant awarded by the Ford Foundation to MINDS to conduct research on two intertwined projects � Financial Governance, Banking, and Financial
Instability in Brazil: Analysis and Policy Recommendations
� Financing Innovation and Development: The Role of Public Banks and Non-Banking Public Institutions. The Cases of Brazil, India and China.
� http://www.minds.org.br/
Outline
� Regulatory and supervisory framework failure in AEs
� Minsky’s alternative approach ¡ Instability Theory ¡ Banking and Financial Regulation
¡ Evolution of financial systems
� New Development strategy
Where Do We Stand?
Brazil: A Bubble Economy
� Kregel (2009) characterized the evolution of developing countries in the New Millennium as a “bubble”, for if the US economy was experiencing a financial bubble the counterpart of that bubble was the extremely beneficial conditions in developing countries and in particular in Latin American emerging markets…we cannot foresee a return to the extremely positive conditions experience by developing countries in the recent past.”
� virtually all of the positive performance that led to achieving the Brazilian dream of meeting the target of the BRICs appear to be linked to a financial model and financial flows that is not likely to be reestablished. The degree of leverage that had become normal in developed country financial institutions will not return, the leverage generated by financial derivatives will now be couched in much stronger margin requirements. This will not only mean lower asset prices but lower global demand for emerging market exports and thus reduced financial flows to emerging markets including the BRICs…there is general similarity across all BRIC economies for they all depend on expanding demand through increasing global trade and global imbalance financed by global financial flows.
Unsustainable global demand and financing patterns
� Prior to the Great Recession, exports from developing and transition economies grew rapidly owing to buoyant consumer demand in the developed countries, mainly the United States. This seemed to justify the adoption of an export-oriented growth model. But the expansion of the world economy, though favourable for many developing countries, was built on unsustainable global demand and financing patterns. Thus, reverting to pre-crisis growth strategies cannot be an option. Rather, in order to adjust to what now appears to be a structural shift in the world economy, many developing and transition economies are obliged to review their development strategies that have been overly dependent on exports for growth. UNCTAD, Trade and Development Report, 2013, p.1-2
A New Global Structure
Global trade growth grounding to a halt
Demand supported by credit growth in EMEs
Current account balance as a percentage of world gross product
Yield Curves of Selected Emerging Market
Economies
Minsky Instability Theory
Periods of growth and tranquility validates expectations and existing financial structures, which change the dynamics of human behavior leading to endogenous instability, increasing risk appetite, mispricing of risky positions, and the erosion of margins of safety and liquid positions
� Kregel-Minsky model ¡ Provision of liquidity
¡ Macro condition
¡ Micro condition
Lifted the external constraint
Policy Rate Selic
Bank Credit % of GDP
Bank claims on the private sector , selected countries, 1990–2012(Per cent of GDP)
Macroeconomic and microeconomic aspects to financial fragility
� Core of Minsky’s financial instability: Assets purchased through the issuance of debt.
� Kregel 2009: � At the macro level: government deficits create cash. � At the micro level: sources of cash flows and cash
flow sensitivity, reliance on position making operations to raise cash.
� Banks, Business firms, and households are short cash.
� “Cash to cover short position”
Public Sector Net Debt
Public Debt Interest Payments
Principles of macro accounting
� one sector’s surplus equals the other sector’s deficit.
� Domestic Private Balance + Domestic Government Balance + Foreign Balance = 0
Domestic Private Balance = government deficit + Current Account Balance
Brazil: Financial Balances Currency issuer and Currency users
(-) 200 000
(-) 150 000
(-) 100 000
(-) 50 000
0
50 000
100 000
150 000
200 000
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Va
lor
a p
reço
s co
rre
nte
s (1
00
0 0
00
R$
)
Non-government financial balance Government sector balance
Financial Balances (sign reversed for GSB and ESB)
-100000
-50000
0
50000
100000
150000
200000
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Va
lor
a p
reço
s co
rre
nte
s (1
00
0 0
00
R$
)
Government sector balance sign reversed Domestic nongovernment sector balance
External sector balance
Financial Balances % of GDP (sign reversed for GSB and ESB)
-6%
-4%
-2%
0%
2%
4%
6%
8%
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Government sector balance sign reversed Domestic nongovernment sector balance
External sector balance
Sectorial Financial Balances
-4
-2
0
2
4
6
8
Nov
-02
Ap
r-0
3
Sep
-03
Feb
-04
Jul-
04
Dec
-04
May
-05
Oct
-05
Mar
-06
Au
g-0
6
Jan
-07
Jun
-07
Nov
-07
Ap
r-0
8
Sep
-08
Feb
-09
Jul-
09
Dec
-09
May
-10
Oct
-10
Mar
-11
Au
g-11
Jan
-12
Jun
-12
Nov
-12
Ap
r-13
% G
DP
Financial Balances % GDP 12-month rolling sum
Government balance External Balance Private sector balance
Brazilian Sectorial Financial Balances
Financial balances as % of GDP 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009average 2000-07
average 2008-09
Nonfinancial corporations -1% -2% -1% 2% 2% 1% 1% -1% -2% 0% 0.04% -1.11%Financial institutions 1% 3% 4% 2% 2% 3% 4% 5% 3% 3% 3.06% 2.80%Public Sector -5% -7% -6% -5% -3% -3% -5% -5% -3% -5% -4.76% -3.73%Households 1% 1% 1% 1% 1% 0% 0% 0% 0% 0% 0.84% 0.18%Rest of the World 4% 5% 1% 0% -1% -1% -1% 0% 2% 2% 0.82% 1.86%
Decomposition of Credit and household indebtedness
Household Debt outstanding and debt service ratio
0
5
10
15
20
25
30
35
40
45
50
Jan
-05
Jul-
05
Jan
-06
Jul-
06
Jan
-07
Jul-
07
Jan
-08
Jul-
08
Jan
-09
Jul-
09
Jan
-10
Jul-
10
Jan
-11
Jul-
11
Jan
-12
Jul-
12
Jan
-13
19881 - Household debt service ratio - Seasonally adjusted data - %
19882 - Household debt - %
20399 - Household debt service ratio without mortgage loans - Seasonally adjusted data - %
20400 - Household debt without mortgage loans - %
Household Debt Service Ratio
0
5
10
15
20
25
Jan
-05
Ap
r-0
5
Jul-
05
Oct
-05
Jan
-06
Ap
r-0
6
Jul-
06
Oct
-06
Jan
-07
Ap
r-0
7
Jul-
07
Oct
-07
Jan
-08
Ap
r-0
8
Jul-
08
Oct
-08
Jan
-09
Ap
r-0
9
Jul-
09
Oct
-09
Jan
-10
Ap
r-10
Jul-
10
Oct
-10
Jan
-11
Ap
r-11
Jul-
11
Oct
-11
Jan
-12
Ap
r-12
Jul-
12
Oct
-12
Jan
-13
Ap
r-13
19879 - Household debt service ratio - Principal - Seasonally adjusted data - %
19880 - Household debt service ratio - Interest - Seasonally adjusted data - %
19881 - Household debt service ratio - Seasonally adjusted data - %
Household debt service ratio – Principal and Interest (Jan 2005 = 100)
0
50
100
150
200
250
Jan
-05
May
-05
Sep
-05
Jan
-06
May
-06
Sep
-06
Jan
-07
May
-07
Sep
-07
Jan
-08
May
-08
Sep
-08
Jan
-09
May
-09
Sep
-09
Jan
-10
May
-10
Sep
-10
Jan
-11
May
-11
Sep
-11
Jan
-12
May
-12
Sep
-12
Jan
-13
May
-13
Household debt service ratio - Principal (Jan 2005 = 100)
Household debt service ratio - Interest (Jan 2005 = 100)
Composition of households bank debt
Minsky, Financial Governance, Banking,
and Financial Instability in Brazil
FELIPE REZENDE, PH.D.
, R e s e a r c h S c h o l a r
R e m a r k s P r e p a r e d F o r T h e C o n f e r e n c e :
“ F i n a n c i a l G o v e r n a n c e A f t e r T h e C r i s i s ” c o s p o n s o r e d B y T h e L e v y E c o n o m i c s I n s t i t u t e O f
B a r d C o l l e g e A n d M I N D S – M u l t i d i s c i p l i n a r y I n s t i t u t e F o r D e v e l o p m e n t A n d S t r a t e g i e s , W i t h
S u p p o r t F r o m T h e F o r d F o u n d a t i o n
E v e r e s t R i o H o t e l R i o D e J a n e i r o , B r a z i l
S e p t e m b e r 2 6 – 2 7 , 2 0 1 3
, NY, USA
MINDS
The conference in Rio de Janeiro also represents the beginning of a multi-year grant awarded by the Ford Foundation to MINDS to conduct research on two intertwined projects � Financial Governance, Banking, and Financial
Instability in Brazil: Analysis and Policy Recommendations
� Financing Innovation and Development: The Role of Public Banks and Non-Banking Public Institutions. The Cases of Brazil, India and China.
� http://www.minds.org.br/
Outline
� Regulatory and supervisory framework failure in AEs
� Minsky’s alternative approach ¡ Instability Theory ¡ Banking and Financial Regulation
¡ Evolution of financial systems
� New Development strategy
Minsky’s view of banking
� Buy assets by issuing liabilities.
� Endogenous money creation
� Growth of private endogenous liquidity during booms.
� Minsky: “Banking is not money lending; to lend, a money lender must have money. The fundamental banking activity is accepting, that is, guaranteeing that some party is creditworthy.” (1986)
Banks treasury security holdings and the Selic Rate
15%
18%
21%
24%
27%
30%
33%
36%
10.0
12.0
14.0
16.0
18.0
20.0
22.0
24.0 N
ov-0
2
Mar
-03
Jul-0
3
Nov
-03
Mar
-04
Jul-0
4
Nov
-04
Mar
-05
Jul-0
5
Nov
-05
Mar
-06
Jul-0
6
Nov
-06
Mar
-07
Jul-0
7
Nov
-07
Mar
-08
Jul-0
8
Nov
-08
Mar
-09
Jul-0
9
Nov
-09
Mar
-10
Jul-1
0
Nov
-10
Mar
-11
Jul-1
1
Nov
-11
Mar
-12
%
Average interest rate on Net Domestic Public Debt (LHS)
Treasury Securities holdings as a share of Deposit money banks assets (RHS)
Changes in the banks asset composition
40%
45%
50%
55%
60%
65%
0%
5%
10%
15%
20%
25%
30%
35%
40%
Jan-
02
May
-02
Sep-
02
Jan-
03
May
-03
Sep-
03
Jan-
04
May
-04
Sep-
04
Jan-
05
May
-05
Sep-
05
Jan-
06
May
-06
Sep-
06
Jan-
07
May
-07
Sep-
07
Jan-
08
May
-08
Sep-
08
Jan-
09
May
-09
Sep-
09
Jan-
10
May
-10
Sep-
10
Jan-
11
May
-11
Sep-
11
Jan-
12
May
-12
Deposit money banks asset composition
Treasury securities Reserves Foreign Assets Claim on the private sector (RHS)
Balance of Credit Operations by capital origin of banking institutions US$ million
Housing Finance System (SFH)
� Under this system, the minimum lending requirement to housing loans is equal to 65% of savings deposits held at banks.
� Outstanding mortgage debt has almost twentyfold since 2002. However, it was widely believed that the growth of savings deposits would be below mortgage lending demand growth. The conventional argument of the advocates of the development of the securitization market is that savings deposits will be insufficient to meet the growing demand for mortgage loans in Brazil, the argument is that mortgage lending loans outstanding will exceed 65% of savings deposits
Liquidity Creation
� The creation of new sources of financing and funding are at the center of discussions to promote real capital development in the Brazil. It has been suggested that access to capital markets and long-term investors are a possible solution to the dilemma faced by Brazil’s increasing financing requirements.
� The Brazilian response to the funding shortfall included policy initiatives to revive Brazil’s capital market funding.
Breaking banks’ monopoly on Liquidity creation
� Regulatory reforms implemented in the late 1990s and during the 2000s have laid the foundation for the development of the securitization market and allowed the creation of new alternatives of liquidity creation.
� The development of the Sistema Financeiro Imobiliario (SFI), established in 1997, would presumably provide the funding necessary for the expansion of the housing market and the corresponding reduction of the housing gap in Brazil.
� The strategy adopted with recent regulatory reforms emphasized loan origination growth by lending institutions and the sale of asset pools to securitization structures (such as receivable investment funds and securitization companies) thus reducing banks’ on balance sheet asset liability mismatches and capital requirements.
� This policy initiative has been driven by the belief that access to capital markets would provide the funding necessary for the expansion of the housing market and the corresponding reduction of the housing gap in Brazil
Breaking banks’ monopoly on Liquidity creation
� The number of structured finance deals and securitization structures sharply increased in the past decade as a series of reforms were introduced to foster the growth of the securitization market in the country.
� Despite the original intent of regulatory reforms in the context of SFI to develop the mortgage lending market, asset-backed securities (ABS) backed by personal loans, auto loans, receivables future flows took off and are common ABS transactions.
� Since the creation of Receivable investment funds in 2001, or Fundos de Investimento em Direitos Creditórios (FIDCs), the range of underlying assets backing securitization deals has broadened including (but not limited to) consumer loans, auto loans, future flow receivables, and non-performing loan portfolios) and originators typical include banks, finance companies, companies (small, medium, and large), and governments.
Lack of Savings and financing mechanisms or short-term portfolio preferences?
� IMF 2012: “Brazil is still stuck in a high interest rate-low duration equilibrium”
Loan Portfolio Yield and funding costs
-
5.00
10.00
15.00
20.00
25.00
30.00
35.00
Jun
-02
Feb
-03
Oct
-03
Jun
-04
Feb
-05
Oct
-05
Jun
-06
Feb
-07
Oct
-07
Jun
-08
Feb
-09
Oct
-09
Jun
-10
Feb
-11
Oct
-11
% Loan Portfolio Yield
Funding cost
Average spread
Average Policy Rate- Selic
Expenses for ALL as a share of banks’ credit portfolio
Brazilian Bank’s return on equity
Capital and Leverage Ratio
Financing Long Term Assets
� Roberto Setubal, chief executive of Itaú Unibanco, points out that
� [Mortgage funding] will need to be developed in Brazil, but in a different way. We will not be financing long-term assets with short-term deposits in the way it was done elsewhere in the world…Since we are facing this liquidity perspective, and let’s assume mortgages will grow at 40% a year because today they are less than 5% of the total portfolio, and let’s also take account of Basel III liquidity requirements, [then] it’s obvious we cannot use savings or demand deposits to close this gap. That’s why there is a big discussion in Brazil about what would be the right funding for mortgages…Given the high level of interest rates this is a problem and this is why Brazil has never developed this before. A lot of current proposals, such as covered bonds, will help but if we don’t have single-digit interest rates it will not happen” (Caplen 2011)
Banks’ Maturity Mismatch
Liability Structure of Brazilian Banks
How to characterize financial systems?
� The important question is related to the costs of carrying a mismatch between the duration of assets and liabilities on the bank balance sheet, that is, if interest and funding risks are carried on banks’ balance sheets.
� Following Kregel (1993), rather than characterizing financial systems as market based or bank based, one should distinguish between the risks that are carried on the balance sheets of banks and other financial institutions
Banks capital and liquidity ratios
Portfolio preferences
Interest Risk Exposure
� During the second quarter of 2013 the top three private banks –Itau Unibanco, Bradesco, and Santander- experienced massive losses, about R$ 11,7 billion, due to a negative adjustment to the market value in their portfolio of securities classified as available for sale caused by changes in the yield curve.
� It is, thus, a high and volatile interest rate environment, due to active manipulations of the central bank’s policy rate, known as Selic rate, that has shifted portfolio preferences towards low duration, short-term assets
Mutual Funds
Repo markets and liquidity creation
� Thank you
Investment as % of GDP
More aggressive increase in treasury investment as % of GDP
A New Perspective on the role of the Public sector to Support a National Development Agenda
� It is not a new insight that growth strategies that rely primarily on exports must sooner or later reach their limits when many countries pursue them simultaneously: competition among economies based on low unit labour costs and taxes leads to a race to the bottom, with few development gains but potentially disastrous social consequences. At the present juncture, where growth of demand from developed countries is expected to remain weak for a protracted period of time, the limitations of such a growth strategy are becoming even more obvious. Therefore, a rebalancing of the drivers of growth, with greater weight given to domestic demand, is indispensable. This will be a formidable challenge for all developing countries, though more difficult for some than for others. In any case, it will require a new perspective on the role of wages and the public sector in the development process. Distinct from export-led growth, development strategies that give a greater role than in the past to domestic demand for growth can be pursued by all countries simultaneously without beggar-thy-neighbour effects, and without counterproductive wage and tax competition. Moreover, if many trade partners in the developing world manage to expand their domestic demand simultaneously, they can spur South-South trade. UNCTAD, Trade and Development Report, 2013, p.3
Elements of a National Development Agenda
� No need to rely on external savings, shift to domestic demand led growth , support domestic income growth and domestic consumption via fiscal policy, Increase government supported infrastructure investment projects, enhancing automatic stabilizers, job guarantee program. fostering the purchasing power of the population in general, and of wage earners in particular, should be the main ingredient of a domestic-demand-driven growth strategy. While export-led strategies focus on the cost aspect of wages, a domestic-demand-oriented strategy would focus primarily on the income aspect of wages, as it is based on household spending as the largest component of effective demand. if wage growth follows the path of productivity growth, it will create a sufficient amount of domestic demand to fully employ the growing productive capacities of the economy… targeted social transfers and public sector employment schemes can play an important complementary role.
(UNCTAD, Trade and Development Report, 2013, p. VII-IX)