How could one of the most successful bank regulatory systems fail so easily? The case of 2001 Argentina

Found an old working paper written by Charles Calomiris (Professor in Columbia University) and Andrew Powell (then Chief Economsit of Central Bank of Argentina) back in 2000, in which they portrayed Argentine banking regulatory system as one of the two or three most successful in emerging economies and a role model for every one to follow.

Browsing through the paper, I am deeply impressed by the quality of Argentine system at that time. The Central bank even had an online database of debtors (I don’t know whether they still supply this service) where general public can enter a company name and know the name of the bank extending the credit, the amount of the credit, the quality category of the loan, and the details of any guarantees extended. Bank depositors, shareholders, and researchers thus were able to monitor banks’ credit exposure at real time. Absolute disclosure as a tool for market discipline! This is what any economists would theoretically advise and seldom expect to be realized in the real world. The Central Bank of Argentina however managed to make it happen. If I read this paper in 2000, I would have invested all my money in these wonderful Argentine banks.

Within a year, however, as everyone has known, Argentine banking system failed. Not the bankers' fault; not the bank regulator's fault. The government screwed up in macro policies and brought down the banking system -- something that Calomiris and Powell thought wouldn't happen, not again!

Several lessons for observers:
(1) It is always more risky to praise a country than criticize it. When you criticize a country, you can never be falsified because you can always argue that the arrival of crisis is just a matter of time. When you praise a county, however, the natural law of mean-reversion will always prove you wrong. Things can only get worse.
(2) As a banker, however smart, honest and hard-working you are, the state is always trying to screw you up by some irresponsible fiscal and exchange rate polices. Don’t under-estimate the evilness of government. In the wake of every crisis, Argentines think: “the government won’t do it (freeze the deposit)  again.”. The government won’t change.
(3) When everything looks so wonderful, something must be wrong! If you cannot find it after doing extensive research, something very big must be wrong.

Can Emerging Market Bank Regulators Establish Credible Discipline? The Case of Argentina, 1992-1999 By Charles W. Calomiris, Andrew Powell
Abstract: In the early 1990s, after decades of high inflation and financial repression, Argentina embarked on a course of macroeconomic and bank regulatory reform. Bank regulatory policy promoted privatization, financial liberalization, and free entry, limited safety net support, and established a novel mix of regulatory and market discipline to ensure stable growth of the banking system during the liberalization process. Argentina suffered some fallout from the Mexican tequila crisis of 1995, but its response to that crisis (allowing weak banks to close) and the redoubling of regulatory efforts to promote market discipline after the crisis made Argentina’s banking system quite resilient during the Asian, Russian, and Brazilian crises. Argentina’s bank regulatory system now is widely regarded as one of the two or three most successful among emerging market economies. This paper traces the evolution of the regulatory policy changes of the 1990s and shows that the reliance on market discipline has played an important role in prudential regulation by encouraging proper risk management by banks. There is substantial heterogeneity among banks in the interest rates they pay for debt and the rate of growth of their deposits, and that heterogeneity is traceable to fundamental attributes of banks that affect the riskiness of deposits (i.e. asset risk and leverage). Moreover, market perceptions of default risk are mean-reverting, indicating that market discipline encourages banks to respond to increases in default risk by limiting asset risk or lowering leverage.