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Chile: Banking Reform and the Financial Sector
Country Study > Chapter 3 > The Economy > Evolution of the Economy > The Military Government's Free-Market Reforms, 1973-90 > Banking Reform and the Financial Sector

BANKING REFORM AND THE FINANCIAL SECTOR


A major policy objective of the military regime was the liberalization and modernization of the banking sector. Until 1973 the domestic capital market had been highly repressed, with most banks being government owned. Real interest rates were negative, and there were quantitative restrictions on credit. The liberalization process began slowly, in early 1974, with the sale of banks back to the private sector, the freeing of interest rates, the relaxation of some restrictions on the banking sector, and the creation of new financial institutions. International capital movements, however, were strictly controlled until mid-1979. In June 1979, the government decided to begin to liberalize the capital account of the balance of payments, lifting some restrictions on medium- and long-term capital movements.

The opening of the capital account resulted in a massive inflow of foreign capital that contributed to Chile's subsequent international debt problems. In 1980 capital inflows were more than double those of 1979 -- US$2.5 billion versus US$1.2 billion -- and in 1981 the level of capital inflows nearly doubled again, to US$4.5 billion.

An important result of the reforms of the financial sector was that the number of financial institutions and the volume of financial intervention both increased greatly. For example, in 1981 there were twenty-six national banks, nineteen foreign banks, and fifteen savings and loan institutions (financieras), a number significantly higher than the eighteen national banks and one foreign bank in operation in September 1973. Furthermore, between 1973 and 1981 the real volume of total credit to the private sector increased by more than 1,100 percent.

At least in terms of increasing the degree of financial intermediation, liberalization was a success. However, it was apparent from the beginning that capital-market liberalization faced three major obstacles. First, interest rates were very high. Second, in spite of the significant growth in the extent of financial intermediation, domestic savings had not increased to the extent that the proponents of the reforms had expected. In fact, domestic savings were at one of their lowest levels in history from 1974 to 1982. There are several possible explanations for the behavior of domestic savings. One of the most popular of these relies on the notion that the appreciation of domestic assets that was taking place at the time, such as stocks and land prices, resulted in a real accumulation of assets without saving. This increase in private-sector wealth was consistent with higher levels of consumption at a given income. Third, and perhaps more important, the rapid growth of the financial sector took place in an environment in which monetary authorities exercised no supervision. As a result, many banks accumulated an unprecedented volume of bad loans, a situation that led to the financial crisis of 1982-83. As a consequence of this crisis, a number of banks went bankrupt during 1983-84, were placed temporarily under government control, and then were reprivatized. By 1992, after monetary authorities had learned the hard way the importance of bank supervision, Chile's financial sector had become highly stable and dynamic.

Data as of March 1994




Last Updated: March 1994


Editor's Note: Country Studies included here were published between 1988 and 1998. The Country study for Chile was first published in 1994. Where available, the data has been updated through 2008. The date at the bottom of each section will indicate the time period of the data. Information on some countries may no longer be up to date. See the "Research Completed" date at the beginning of each study on the Title Page or the "Data as of" date at the end of each section of text. This information is included due to its comprehensiveness and for historical purposes.

Note that current information from the CIA World Factbook, U.S. Department of State Background Notes, Australia's Department of Foreign Affairs and Trade Country Briefs, the UK's Foreign and Commonwealth Office's Country Profiles, and the World Bank can be found on Factba.se.

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