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AmericasJuly 3 2007

Pragmatism kicks in

Elected on an anti-poverty mandate, Ecuador’s government may be clashing with private banks over microloan fees but it accepts the economy should be capitalist, underpinned by a competitive banking system. Jane Monahan reports from Quito.
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To further his government’s leftwing goals, Ecuador’s president, Rafael Correa, has no qualms about commenting on the market operations of the country’s 24 commercial banks, six of which – Banco del Pichincha, Banco del Guayaquil, Banco del Pacífico, Produbanco, Banco Bolivariano and Banco Internacional – account for 75% of the system’s total assets ($11.9bn at end-March 2007 – 25% of gross domestic product). However, like his about-face in February, when his government finally made a coupon payment in full on internationally traded bonds after repeatedly threatening default, so it is in relations with the country’s banks: reality is forcing the administration to recognise its limits.

It is the government’s belief that alongside a strong state sector, a co-operative sector, and a mixed public and private-owned company sector, Ecuador should also have a hard-nosed capitalist economy including, prominently, competitive and efficient banks.

Microfinance initiatives

Ricardo Patiño, the country’s new finance minister, is an unusual incumbent based at the ministry building, a drab complex on Avenida 10 de Agosto in the modern part of Quito, Ecuador’s Andean capital. It is an example of his atypical background that in Guayaquil, Ecuador’s largest city where 52-year-old Mr Patiño and Mr Correa grew up, he established a co-operative, which in four years increased its meagre capital from $4000 to $1.5m and helped 18,000 low-income women start small businesses.

That experience convinced Mr Patiño – who was deputy minister to the president in 2005, when Mr Correa was finance minister in the last government – about the effectiveness of microfinance in fighting poverty and creating jobs. For this reason, Mr Patiño told The Banker: “The government plans to create a new under-secretary for economic solidarity for the country’s 550 co-operatives”, and a new superintendency with exclusive responsibility for overseeing Ecuador’s rural financial institutions, co-operative banks and microfinance.

Mr Patiño points out that the interest rates in microfinance average 18% but “these charges can go as high as 40% once commissions and fees are included”. There are currently no limits in Ecuador on how much banks can charge in fees. Such rates are “much too high” and “not competitive”, says Mr Patiño.

However, Robalino Gonzaga, president of the private bankers association in Quito, says that when the finance minister asked at a recent meeting whether banks that provide microfinance (Banco del Pichincha, Banco del Solidario and Procredit) and rural microcredit institutions could provide microcredits at 5% interest and without commissions, bankers replied that such a rate was not “realistic” considering the high operational costs in making microloans.

Total credit to the private sector grew to $7.9bn at end-2006, 22% more than in 2005. However, although microcredits increased as a percentage of this total, they still only amounted to $487m (6% of the total), far less than the government wants. In contrast, lending for large companies amounted to $4.7bn (59% of the total), consumer credits were $2bn (25% of the total), and housing loans were $782m (10% of the total).

Bankers fear fee cap

As a result, Mr Gonzaga says, bankers fear that the government, in its determination to address the needs of the 67% of the rural population that lives in poverty (a campaign pledge), may decide to cap interest rates and limit commissions by decree.

However, Roberto González, vice-president of Banco del Pacífico, Ecuador’s third largest bank, says “It is not at all clear, without very serious reform, if Ecuador’s banks will be able to reduce their rates and commissions.”

Fernando Pozo, general manager of Banco del Pichincha, Ecuador’s biggest bank, warns that if the government introduced controls on interest rates and fees, it might partially undermine the recovery in terms of liquidity, solvency and profits made by the banks since Ecuador’s 1998-2000 economic and financial crisis. Such controls “could be the starting point of another potential crisis and create a lot of uncertainty”, Mr Pozo says.

In this situation, and with neither side wanting to revive those crisis-ridden times – when the government intervened in 16 banks representing two-thirds of the system’s assets, and bank deposits were frozen – Mr Patiño has showed that the new government is capable of being pragmatic as well as radical. “We want to reach decisions on the various matters and differences, but by consensus [with the banks],” Mr Patiño says.

Project finance

Just when consumer lending is one of the fastest growing segments in the private credit market (which is for the purchase of imported goods like cars and household appliances, among other things, but which does not create jobs), Mr Patiño says he would like banks to make more “productive” investments in construction, national industries, infrastructure and agriculture.

Mr Gonzaga opposes this idea. “It is not the function of banks to finance government programmes,” he says.

Moreover, says Mr Gonzaga, a fundamental weakness in long-term lending by the banks is that 70% of the system’s total deposits (amounting to $8.7bn at the end of March and held in current accounts, currency deposits and short-term savings accounts) have only three-month terms or less, while the average terms for bank loans is two to three years, and for mortgages eight to 10.

“This is a reality. There is a mismatch. Banks cannot lend long term when their deposits are short-term,” he says.

Mr Patiño says the government would like banks to change their policy of investing nearly all their reserves abroad – between $1.5bn and $2bn. The nation’s interests would be better served if that money was invested “in government paper or as credits in Ecuador”, he says.

However, Mr Gonzaga says, following Ecuador’s move to a dollar economy in 2000, the country has no lender of last resort, so banks have to make their own arrangements to safeguard depositors’ money, in case of a crisis.

Many banks in Ecuador also have dynamic international operations, for instance in trade finance, so they need liquidity abroad, says Mr Gonzaga.

Bankers’ concerns about the government’s future financial policies do not extend to fears about bank nationalisations. In the oil sector, which accounts for almost 50% of the country’s export revenues, and in the banking sector, the government has emphasised that it has no nationalisation plans.

The administration is intending to recapitalise and reorganise the country’s various second-tier, state-owned financial development agencies, however. And, according to Mr Patiño, the government could “easily allocate $100m to $200m a year” to the state-owned institution Banco Nacional de Fomento, which has branches throughout the country, to give it a bigger and more effective role in the system, in microfinance and lending to small and medium-sized companies in tourism, industry and agriculture.

Competitive banking

Endorsing the idea that Ecuador needs competitive and efficient banks, Mr Correa, who has a PhD in economics from Illinois University in the US, said in April that he supported the privatisation of Banco del Pacífico, the only private bank subjected to intervention during the 1998-2000 crisis that is still operating and still owned by the central bank. He has also said he would prefer the buyer to be a foreign bank because this “will generate more competition in the system”.

Support for internal banking reform is coming from inside the sector. One supporter is Banco del Pacífico’s Mr González, a 43-year-old Spaniard with experience of working in banks in other Latin American countries. After independent management was appointed in October 2001 at the behest of the World Bank, Banco del Pacífico introduced a more modern banking approach to Ecuador, based on making efficiency and profitability priorities and on decentralising loan approvals and other bank operations, he says. “Every branch is a mini-bank at Banco del Pacífico.”

In contrast, according to Mr Pozo, Banco del Pichincha (named after an Andean mountain, a region and an independence battle), the oldest bank in the system, with a head office in Quito, follows a more traditional banking model based on size, the number of branches and bank operations, and centralised operations. He insists there are other reasons for the bank’s recent growth, though. For instance, it will soon be the first Ecuadorian bank to open an agency in Madrid complementing some of the work already done by Banco del Pichincha-Agencia Miami, a subsidiary bank, managing US remittances.

The remittances market is one that cannot be ignored, Mr Pozo says. “Remittances are now Ecuador’s second biggest source of revenue, after oil earnings, and amounted to more than $2bn in 2006.”

Two-sided coin

Disagreeing, Mr Patiño says high remittances are no cause for celebration. Although the economy grew 4.6% in 2006 – there was a current account surplus and inflation, at 3.7%, is “under control” – unemployment of about 9% a year is “quite high, especially considering two million Ecuadorians – about a sixth of the population – have emigrated to find jobs”, says Mr Patiño.

Although Banco del Pichincha had $2.9bn in assets at the end of 2006, 25% of the system’s total as well as 232 branches and 4000 employees, it was not the most profitable bank in the system at the end of March; and it ranked 11th and ninth in non-performing loan and efficiency ratios respectively, at the end of 2006.

Banco del Pacífico, on the other hand, with $1.3bn in assets and 1400 employees, led the system in profits and efficiency ratios at the end of March.

Mr González attributes this positive performance to the bank’s different banking strategy, which has included as a priority a 40% reduction in the bank’s total operational costs, (including a 47% decline in staff) from $62m in 2001 to $37m in 2006. As a consequence, the bank was able to launch a new product on the market in 2004: a housing loan, Hipoteca 10, at rates of 10% when the average rates for mortgages then were 16% to 17%.

The loan was so popular that the bank’s competitors soon followed suit. However, because of their high fixed and operational costs, many banks tended to compensate for the lower income from housing loans with high rates (24% to 25%) for consumer and personal loans, and significantly higher fees and commissions.

Unsurprisingly the ratio for past-due loans is now much higher in Ecuador for consumer and personal loans than it is for housing loans, Mr González says.

Small wonder that a high-ranking official at the Bank Superintendency says that for banks to be more efficient and competitive, the challenge is not just in reducing fixed and operational costs. “There also needs to be better management of credit risks and [in view of the mismatch in deposits and loans] better management of liquidity risks,” the official told The Banker.

Vested interests

World Bank analysts and Eduardo Cabezas, ambassador to the UK before becoming Ecuador’s central bank president in mid-2006, largely blame the 1990s bank crisis on the power, at the time, of bankers and deeply entrenched interests over institutions like Congress and the judiciary, as well as weak supervision.

“The owners of the banks gave themselves credits and gave their companies credits and knew the central bank would back them up [with financial assistance] if necessary. Bankers had power economically and politically,” says Mr Cabezas.

There was also no consolidated supervision at the time, despite most banks being part of large financial conglomerates that included difficult-to-supervise fund management companies and offshore banks. (Today most banks still belong to large financial groups though many have closed their offshore operations).

While the total bank insolvency losses caused by the crisis amounted to “about $4bn, about 20% of GDP at the time, what was worse was that over 50% of national savings was lost. The losses were mainly paid by the public, the people who deposited their money, the small saver”, Mr Cabezas says.

Against this background, in the wake of the banking crisis, stricter regulations were enacted for the banking sector, including consolidated supervision, higher capital standards, stricter reporting requirements and prohibitions on lending by banks to companies and individuals if they are financially tied to the banks through shareholdings and management.

There has also been a change in the areas and emphasis of the superintendency’s oversight to internationally recognised risk-based supervision. And supervisors have received training in risk management organised by international consultants Deloitte and Touche.

Political scene

The crisis helps to explain some of the public’s repudiation of traditional elites and traditional institutions, like Congress – which most Ecuadorians view as corrupt and inept; and also why a crushing 82% of voters backed Mr Correa’s call in an April 15 referendum for the establishment of a national assembly to rewrite the country’s constitution and foster more participatory democracy.

The new assembly will have broad powers and it could reform, not only the legislative, judicial and executive branches, as Ecuador’s president has said, but also the banking sector, with changes at the superintendency and the Deposit Guarantee Agency, and new rules for private and state-run banks, according to Mr Patiño.

Mr Correa, who was elected last November with the support of the country’s indigenous majority and middle classes but without the backing of any traditional political parties, now has an opportunity to consolidate his power. His supporters are widely expected to win a majority in the new assembly when it is elected in September.

Pragmatist: Ricardo Patiño says the government seeks consensus in decisions about the banking system

Eduardo Cabezas: blames 1990s bank crisis on the power of bankers’ interests and weak supervision

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