Is Argentina’s banking system at risk?

12th September 2019

By Miguel Angel Boggiano

Is Argentina’s banking system at risk?

With the traumatic memories from the “corralito” still fresh, Argentines fear that this new economic crisis will lead to a repeat of 2001, when withdrawals were frozen and savings were lost after a run on the country’s banking system.

But are both situations comparable and destined to a similar ending? Or is the system more solid this time around?

</p> <h2><strong><em>Corralitos</em></strong><strong> and <em>cepos</em></strong></h2> <p>Words coined in Argentina such as “<em>corralito</em>” and “<em>cepo</em>” can be confusing for non-natives, so let’s start by explaining what they mean.</p> <p>The <em>corralito</em> was a restriction on withdrawals from Argentine banks during the last few weeks of the one-to-one peso-to-the-dollar convertibility, in December 2001. The decision was taken as a growing amount of depositors, fearing that the Argentine peso’s peg to the dollar was coming to an end, withdrew their money from banks to store their savings in US cash instead.</p> <p>A few months later, with the peso now at 3-to-1 to the dollar, dollar depositors only got 1.40 pesos per each dollar held in their accounts, while peso-denominated deposits also lost purchasing power due to the devaluation.</p> <p>The <em>cepo</em>, meanwhile, was a restriction on foreign currency purchases imposed shortly after Cristina Kirchner’s 2011 re-election. It was enacted as a growing amount of peso holders exchanged them for US dollars, fearing that the roughly 4-to-1 exchange seen at the time could not be sustained much longer, in order to ease pressure on Argentina’s Central Bank reserves.</p> <p>Unlike the <em>corralito</em>, existing dollar deposits were not affected by the <em>cepo</em>, although many still withdrew their money during that period as a precautionary measure. That <em>cepo</em> was lifted when Macri took office in 2015.</p> <h2><strong>A new financial crisis</strong></h2> <p>With investors escaping from Argentine assets and from its currency, Macri finally decided to <a href="">re-impose the <em>cepo</em></a> earlier this month. This time, however, it could be described as a “guilt-ridden <em>cepo</em>,” “<em>cepo</em> lite” or “mini-<em>cepo</em>”. As the exchange rate shot upwards again amid the decision to “<a href="">re-profile</a>” Argentine debt, the government applied some lukewarm restrictions regarding the purchase of dollars.</p> <p>The move yielded some positive short-term results for the government and the peso-to-the-dollar exchange rate made a pause, bringing some modest relief to Argentines. But it is important to notice that, while the official wholesale exchange rate has stood at 56 pesos per dollar over the last few days, the blue-chip swap rate has soared past 65 pesos. The <a href="">loss of Central Bank reserves</a> has not let up either, so the future is far from certain.</p> <p>Which begs the question I am getting most frequently as of late: Will these restrictions end up with a new “<em>corralito</em>”?</p> <p>Let’s start with a quick answer. Today, the dollar-denominated share of Argentina’s financial system is more solid than it was in 2001. This doesn’t mean that the system is fully armored, but it does reduce the probability of a <em>corralito</em> reprise when compared to those moments.</p> <p>It is important to emphasize this: we are not dealing with certainties, but with probabilities.</p> <h2><strong>Argentina in 2001</strong></h2> <p>Back in 2001, regulations allowed Argentine Banks to hold only a very small fraction of dollar deposits on reserve (what we call “<em>encajes</em>” in Spanish). The rest could be loaned to the public with almost no restrictions.</p> <p>Mandatory reserves, or <em>encajes</em>, which banks were not allowed to loan, were closer to 10 percent<em><strong>*</strong></em>. That meant that for every hundred US dollars deposited, the bank could turn around to loan back US$90, while only US$10 remained in custody within Argentina’s Central Bank’s vaults.</p> <p>This led to a very dangerous phenomenon. If out of US$100 that, say, John Doe deposited the bank only reserved US$10 and lent US$90 back to Jane Smith, the US$90 loaned to Jane Smith could also find their way into the bank. And out of Smith’s US$90, the bank would again only reserve 10%, and loan an additional US$81 to John Smith. And so on and so forth.</p> <p>This mechanism is what is known as secondary creation of money, and it generates a multiplying effect. With it, Argentina’s banking system was creating dollars in the system’s books as if it were a US bank. This craziness made the system extremely vulnerable, because Argentina’s Central Bank was never going to be able to print US dollars if a moment of panic came and everyone wanted to withdraw cash to hold their physical dollar bills. And that’s exactly what ended up happening.</p> <p><strong><em>*</em></strong><em>The exact number was somewhat higher than 10 percent, though it varied depending on the type of deposit and due to <a href="">multiple backs and forths</a> in Central Bank regulation during the crisis-laden 2001. Round number is used for simplification purposes. </em></p> <h2><strong>Argentina in 2019</strong></h2> <p>Today, the <em>encajes</em> or mandatory reserves are closer to 50 percent. This means commercial banks loan a much smaller share of the US dollar deposits they receive.</p> <p>In addition, banks cannot loan these dollars to anyone, as they could back in 2001. They can only loan this money to dollar-generating sectors, like exporters. This is very important because it limits the secondary creation of dollars, which is not as big as it used to. It still exists, but in a more limited way.</p> <p>To sum up, banks can loan a smaller portion of US dollar deposits today, and they can only loan it to sectors whose revenue is also denominated in dollars. This makes the multiplying effect much smaller, and the system more robust.</p> <p>But one fact remains very clear: if every dollar depositor still wants to withdraw their money simultaneously, there won’t be dollars for everyone. To reiterate, the situation is significantly more robust than in 2001, but the system is not bulletproof. For it to be so, banks should be forced to keep all their current account deposits in reserve.</p> <h2>Alarming figures</h2> <p>For now, a data point that should be closely followed is the amount of dollar deposits within the financial system:</p> <img class="wp-image-3581 aligncenter" src="" alt="Private-sector dollar deposits in Argentina as of September 2019" width="609" height="353" srcset=" 300w, 768w, 600w, 849w" sizes="(max-width: 609px) 100vw, 609px" /> <p>Between August 11’s primary elections and September 6, dollar deposits fell by 27 percent, a figure which is undoubtedly alarming, even if the total amount of dollars held by banks is much higher than during the Kirchnerite administrations.</p> <p>What really matters today is to stop the loss of reserves held by the Central Bank. This is why the results of the new regulations forcing exporters to sell their dollars will need to be analyzed closely. The trend of uninterrupted reserve losses needs to be urgently reverted.</p> <p>

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Miguel Angel Boggiano

Miguel Boggiano is the founder and CEO of Carta Financiera and teaches Behavioral Finance at the University of San Andrés. He has an Economics Master’s from the University of Chicago and a public career in trading and financial analysis, with frequent appearances as guest specialist in Argentine print, TV and radio.
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