Cautious Regulation is Economic Savior

By Jaylan Boyle, Contributing Reporter

RIO DE JANEIRO – The mechanism that precludes the possibility of a Brazilian Bernard Madoff is just one example of regulation that has helped the country avoid the worst of the global economic crisis.

Madoff, a prominent Manhattan asset manager and philanthropist, pleaded guilty in March to operating a Ponzi scheme (whereby investor’s returns are paid to them from their own investments), the largest ever investor fraud committed by a single person. Prosecutors have estimated client losses at more than US$65 billion, and it is expected that at his June 29th sentencing he will be given enough of the maximum 150 year sentence to keep him in prison for the rest of his life.

Paulo Oliveira, Director for New Business at BM&F Bovespa, the exchange formed last year following the merger of the Sao Paulo derivatives and stock exchanges, said recently that “there could never be a Brazilian Madoff. The regulators always want to know both sides of all trades.”

Many countries require asset managers to disclose only their net position, rather than the more detailed accounting required by Brazilian law, which would not have allowed a Bernard Madoff to invent client trades with no obligation to provide proof.

This is just one aspect of Brazilian financial regulation that is being examined afresh by the world’s economic administrators for the lessons they provide in mitigating financial downturn. It is noteworthy however that not all of these regulatory measures came about intentionally: some are the result of lethargic Brazilian modernization in the years prior to the crisis.

Alexandre Tombini, Director for Regulation at Brazil’s Central Bank, says this slower pre-2007 approach was due to traditionally cautious regulatory behavior. Brazil has endured several periods of severely painful financial turmoil in recent years, though the situation stabilized after runaway inflation was reigned in during the mid-1990s. “We are used to dealing with challenging environments, in our institutions and our regulations,” said Mr Tombini. “Everything we have done since the mid- 1990s has tended to take a more cautious approach.”

In a further example of regulation that prior to the present crisis may have been called prohibitive, the minimum required level of capital ratio – the ratio of capital to assets maintained by banks – is 11 percent in Brazil, with many keeping levels of 16% or more. Many countries are bound by similar requirements, however almost all others have taken the minimum recommended by the BIS (Bank for International Settlements, an organization that helps foster cooperation between central banks) of 8% as the norm.

In combination with Brazil’s very high 30% reserve requirement (the percentage of deposits that banks are required to hold with the central bank), this meant that at the onset of the present crisis, Brazil’s central bank was able to release R$100 billion (US$51.4 billion) overnight to ensure banks had sufficient funding.

One example of a downside to this cautious approach however is that it helps to create a prohibitively cost of borrowing in Brazil.