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AmericasMarch 10 2009

Robust chile hopes for the best

A conservative fiscal approach has left Chilean banks well placed to ride out the global financial downturn. However, opinion is divided on just how tough things are likely to get in the immediate future. Writer Jason Mitchell in Santiago.
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Chile’s banking system is one of the most robust in Latin America and is well placed to withstand a deep global downturn, despite the country having one of the most open economies in the world.

Bank lines comprise a low 7% of total bank funding, according to rating agency Moody’s Investors Service. The banks have a Tier 1 capital ratio of 9.51% excluding subordinated bonds and voluntary provisions, according to the country’s Superintendent of Banks and Financial Institutions (SBFI). Credit risk – in terms of provisions for loans – has been stable at 1.6% of total loans since May 2008 and the loan default rate has remained at 0.9% since July.

Highly capitalised

Overall, Chilean banks have been performing very well, according to Don Hernán Somerville, president of the Chilean Association of Banks and Financial Institutions (ABIF). “In my view, they are highly capitalised with very good rates of return on equity and assets; they are very well regulated, extremely well supervised and have a strong degree of self-regulation,” he says.

On average, Chile’s banks have a return on equity (RoE) of 18%, while the leaders, such as Banco de Chile and Santander, have an RoE of 23% to 28%. The average return on assets is between 1.5% and 1.8%, and for the big banks it is 2% to 2.2%.

Gustavo Arriagada Morales of the SBFI believes the strength of the capital base and the solvency that have characterised the Chilean banking system are being maintained. “In September, the level of consolidated capital adequacy was 12.2%, with all financial institutions registering a rate above 10%. Furthermore, the proportion of basic capital against total assets reached 6.83%, way above industry norms that establish it at 3%,” he adds.

Jeanne Del Casino, a Latin America banking analyst at Moody’s, compares Chile’s improved standing with that of South American giant Brazil: “The large Chilean retail banks are best positioned because they have a broad access to funding and they have a natural core cheap funding base (retail and institutional deposits). In Brazil, smaller entities are suffering a drying up of their credit; we have not seen that in Chile. Most of the lending is funded through deposits. The whole structure is very conservative. They are mainly lenders; it is a traditional banking system.”

Banco Santander is the biggest bank in Chile, with a total market share of about 23%. Banco Chile has 21%, Banco Credito 16% and BBVA 8%. Canada’s Scotiabank acquired Banco del Desarrollo in August 2007 for $1.03bn and their merger should be complete within the next few weeks. The combined bank will have a 10% to 12% share of the market. The country’s only state-owned bank, Banco del Estado, has a 7% to 8% share.

Rise in lending

According to the SBFI, between January 1 and October 31, 2008, total bank lending increased by 12.04%. (Surprisingly, October saw one of the biggest rises of the year at 4.55%.) And during the same period, home loans expanded by 9.47% and commercial loans by 14.18%.

Conversely, consumer lending – one of the fastest-growing sectors in recent years – has started to drop, suggesting a drying-up of consumer confidence. On average, consumer lending has fallen by 0.17% a month since May and for the 10 months to October, it dropped an overall 1.68%. In October, provisions for consumer loans stood at 5.46% of total loans of this type.

According to James Callahan, general manager of Scotiabank in Chile, lending is still growing but the rates of growth are declining, especially in the consumer sector. “Credit cards are doing quite well overall but we are expecting to see some deterioration in the future. Provisions have started to become quite high in their case,” he adds.

Credit stored

There are about four times more cards issued by retailers than banks, says Mr Callahan. Credit provided by retailers has been growing at a faster rate than bank credit but retailers are subject to looser regulation than the banks. “[ABIF] believes that it would be beneficial for all parties providing consumer credit to pass information about debtors to a credit bureau that can maintain complete credit information,” he adds. “This would lead to better disclosure, better transparency. There is asymmetry in the credit information that is available.”

While retailers enjoy full access to all the banking system’s financial information about clients, banks cannot obtain this kind of information about the 20 million storecard-holders, he says. “Storecards have been developing for the past 15 years or so. It is quite a sophisticated market. The retailers are good at data mining and setting the right rates. Default rates on these types of loans have been rising but I don’t think it will get to the point where it will be a serious issue.”

Chile’s economy has been growing strongly for the past few years but not at the elevated rates seen in the 1990s. Some economists believe it has missed an opportunity to expand more rapidly, especially during the past few years when commodity prices have been at record levels (the country is the world’s most important exporter of copper).

Moody’s estimates that economic growth last year was 4.5% and predicts 3.5% this year, although many economists believe that this is wildly optimistic – ABIF’s forecast is a more modest 2%.

The country has been conservatively managed and has been running the highest budget surplus for any Latin American country, at about 7% of gross domestic product. The country’s total reserves add up to $51bn, including the Economic and Social Stabilisation Fund, a sovereign wealth fund that makes up about one-third of the total reserves. This compares with the banks’ total external debt of $13bn.

In 2007, the government – led by the Socialist Party’s Michelle Bachelet since March 2006 – came under fire. It was criticised for adopting such a tight fiscal policy and for not investing more in public education and health, for example.

Caution is best

However, now many economists are saying that this cautious approach has put Chile in the best position regionally to weather a global economic slump. Maturities in the fourth quarter last year totalling $2.7bn were covered more than twice by the total of $6bn in reserves accumulated by the central bank since April.

Despite such figures, Ricardo Ffrench Davis, professor of economics at the University of Chile, cautions: “I believe the Chilean economy is in relatively good shape compared to its neighbours in the region but we have problems that have only just started. There is an adjustment in the real economy taking place now.

“We have had a second half of the period of democracy that has seen economic growth at a much lower rate than the first half. The second half has grown at 4% while the first half expanded at 7%, and that was sustainable. Under [former dictator] president Augusto Pinochet it increased by 2.9% annually. One of my main concerns is why the second half has expanded more slowly: we could have done even better.”

He adds that the country’s biggest advantage today is the Economic and Social Stabilisation Fund, which means that it does not have to borrow from the international community. Codelco, the country’s main copper producer, remains in state hands, and has provided the government with a large flow of revenue in the region of $600m to $700m a year for many years. Although some observers say the state should have privatised the business at the end of 2007, when it could have been sold for up to $80bn, others believe that copper is a national asset and should remain in the public sector.

Time to spend

Mr Somerville of the ABIF says: “I am a member of the advisory board for Asia-Pacific Economic Co-operation and I am in contact with President Bachelet. I recently told her that it has been great that during the good periods the country has saved but now, when things are starting to look bad, it is time to spend.

“My recommendation would be to spend wisely on infrastructure, to reduce taxes and to increase competitiveness. We have been requesting more flexible labour laws – but this has proved politically impossible in the past – and a reduction in the capital gains tax and in stamp duties. At some point, there will be some kind of fiscal stimulus.”

Others believe that 2009 will be challenging. Raimundo Munge, director of corporate strategy and finance at Santander in Chile, says: “The Chilean economy is a very small one and it is very open. Therefore, it would be unlikely that we will be completely isolated from what is going on outside, especially because of the expectations that the domestic economy will be cooling down. Furthermore, many of our trading partners will be growing much more slowly than before.”

He says that Chile’s exports are relatively diversified in terms of markets but the country is fairly concentrated in terms of commodities, mostly copper and pulp. With the EU and the US in recession and with China slowing down markedly, Chile is bound to be affected.

Claudio Larraín, a partner and head of institutional management at local investment bank LarraínVial, says: “During the past few years, the economy has been driven mainly by domestic demand, by the retail sector and by investment, more than by the export of commodities and production. We are expecting a sharp decline in consumption this year because of what has been happening globally. One area of the population that will suffer the most is the low paid, and they have been one of the keenest groups to take up store cards.”

Strong position

Most commentators believe that Chile will cope comparatively well this year and next, as long as the global economy does not fall into too profound a recession. The SBFI’s Mr Morales says that his organisation has stress-tested all of the country’s banks and they will be able to withstand a major global downturn. But, he adds that if the world suffers from a severe depression, the worst-case scenario could change and banks could suffer more than the models suggest.

One of Chile’s greatest strengths has been the size of its private pension funds in relation to the size of the market. In Latin America, only Brazil compares well with Chile in terms of the sophistication of its pension funds and the depth of its capital markets.

Moody’s Ms Del Casino says: “Bank managements in Chile have been liquefying their balance sheets since the beginning of the US subprime crisis in 2007. Loan leverage is coming down, and liquidity ratios have been improving. Core deposits have also been fairly stable, including those sourced from the pension funds, which are less likely to place funds abroad, even though the limit for foreign investment was recently increased to 45% from 30%. Nevertheless, we continue to view the banks’ increasing dependence on pension funds as an important concentration of risk.”

On December 11, the central bank left interest rates unchanged at 8.25%, a decision widely expected by analysts because inflation had been running at a 14-year high. However, some economists criticised the bank for acting with hindsight. They say that it was slow to put interest rates up early last year when inflationary pressures mounted and that now it is being too timid in dropping rates.

Future elections

Ms Bachelet’s popularity as president has declined dramatically during the past two years, after she failed to handle several domestic crises with adequate firmness. She is unlikely to stand for re-election in March next year and Sebastián Piñera of the centre-right party, National Renewal, is current favourite to win the 2010 election. The billionaire businessman narrowly lost the election to Ms Bachelet in 2006.

Like Chile itself, the banks and financial institutions are conservatively managed organisations that should be able to withstand a dramatic downturn in the rest of the world, as long as this is not too deep. But if the slump turns out to be profound, the country’s very open economy will probably cause it to be badly affected.

COUNTRY FACTS

Population16,454,143Population growth rate0.905%Area748,800 sq km

Real GDP growth4%

Growth per capita$15,400

Current account-$1.574bn

Key sectors

• Industry: 50.5%• Services: 44.7%• Agriculture: 4.8%

Labour force

7.32 million

Source: CIA World Factbook, 2009

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