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Banking crisis: Does Chile point the way ahead?

The resolution of one Latin America banking crisis in the early 1980s could provide lessons for today’s policymakers.

Ever since the financial crisis began in mid-2007, commentators have sought parallels in the hope of finding a template for curing sick banks, especially in the US and UK. The obvious examples are the banking crises in the US in the 1930s, Sweden in the early 1990s and Japan later that decade.

In terms of size and complexity, these crises are probably the most comparable with the one today. There is, however, another example that policymakers should pore over. That is the Chilean banking crisis of the early 1980s, as economists Vitoria Saddi and JF Hornbeck, among others, have recently argued.

Although there are key differences between that crisis and today’s – not least in their origins – there are some valuable lessons that Chile’s recovery plan provides for policymakers.

The Chilean crisis was macroeconomic in origin. In the late 1970s the Andean nation liberalized its financial system, including banking regulation that culminated in a credit-led boom between 1980 and 1981. Bank lending almost doubled between 1979 and 1981 to 45% of GDP, according to Hornbeck. As the global economy entered recession in 1981-82, however, that boom turned into bust.

A deteriorating economic environment and a weakly regulated financial system led to an inevitable outcome – stressed borrowers and overextended banks.

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