You would be hard pushed to find a single year in recent memory without at least one country either recoiling from the impact of trouble generated overseas – Asia and Russia spring to mind – or, more often, caused closer to home. And while economic or political crises may precipitate trouble for the banking sector, Latin America’s banks are equally capable of creating crises of their own. Consequently, much attention has turned recently to the possibility of identifying root causes and spotting impending problems before it is too late.
Enrique Iglesias, outgoing head of the Inter-American Development Bank (IDB), commented recently that, despite much macro-economic and regulatory reform in recent years, the risk of further banking crises in Latin America had not fully receded. “Banking crises occur throughout the world, but they are particularly severe and frequent in developing countries, and especially so in Latin America,” he warned.
An IDB report published this year, Unlocking Credit: The Quest for Deep and Stable Bank Lending, found not only that banking systems in Latin America and the Caribbean underperform systems in other parts of the world, but also that they are more shallow and more volatile. It noted: “In Latin America, 35% of countries have experienced recurrent (banking) crises, almost three times higher than any other region. These results are striking and indicative of how much remains to be done to achieve banking stability in the region.”
Dominican debacle
The most recent Latin American banking crisis, which flared up in the Dominican Republic in 2003, was a clear example of regulatory failure. It was sparked by the discovery that one of the biggest private banks in the country, Banco Intercontinental (known as Baninter), was running off-books dealings that were bigger than its reported ones. Baninter and two other large banks collapsed, dragging the exchange rate down with them and, thanks to a government bail-out, sent national debt soaring. The banking system is gradually recovering from the debacle, but it will take time to improve regulation and restore confidence.
Indeed, the Dominican Republic emerges as one of the world’s riskiest banking systems in a report published in July by Fitch Ratings. The report ranked 81 banking systems worldwide. Fitch’s Banking System Indicator measures intrinsic banking sector risk on a scale of A (very high quality) to E (very low quality). On the Banking System Indicator, of 11 countries rated as E, five were in Latin America: the Dominican Republic, Argentina, Bolivia, Ecuador and Uruguay. Brazil, Colombia, El Salvador, Panama, Peru and Venezuela all rated D. In Latin America only Mexico (C) and Chile (B) made it into the higher reaches.
Ecuador remains a risk because of political turmoil that includes stoppages in oil production as a result of recent demonstrations. Its banking sector has undergone considerable consolidation, with about one-third of banks closing or being bought over the past few years.
A good test came last year following rumours (started, of all places, on the floor of Congress) that the country’s biggest bank, Banco del Pichincha, was in difficulties. It was able to withstand the subsequent short run on deposits. “Does that mean the system is crisis proof?” asks Peter Shaw, Latin American banking analyst at Fitch in New York. “No, but it is in much better shape.”
Mixed results
It is less clear whether Argentina’s banks have recovered to the same extent from the crisis that followed that country’s debt default in late 2001. As Carina López, credit analyst at Standard & Poor’s noted in a recent report, “The start of the year has been auspicious for Argentina’s banks. Asset quality continued improving in private banks, with problem loans reducing to 12.8% from the high peak of 30% recorded by the end of 2003.” Yet the problem remains that a high proportion of banks’ assets are in government debt, and that the sector functions more as a payments system than as a source of lending. Moreover, government debt held by the banks has yet to be marked closer to its true value. This, too, will inevitably be a lengthy process. As Fitch’s Mr Shaw points out, “One tool of regulators is forbearance and in this case, that seems appropriate.”
Also under a cloud is Uruguay, a direct casualty of its neighbour’s default partly because a large share of foreign deposits held at its banks were Argentine and quickly evaporated. The government made it clear that it was up to banks’ shareholders to solve their liquidity problems and only stepped in where that was not possible. Assets taken over are now up for sale, and the sector is building its way to recovery.
Foreign invasion
Such problems notwithstanding, Latin America is in fact a highly diverse region with pronounced differences in terms of economic stability and the quality of banking regulation. Chile’s banking industry, while small compared to those in Mexico and Brazil, is a shining example of the results of first-rate regulation. Problems in Mexico, mostly to do with poor asset quality, have been resolved following the wholesale arrival of foreign banks.
Brazil, by contrast, shows how well-managed, large local banks can steer a steady course through a turbulent economy. The scale and particular skills needed to do so have kept the participation of foreign banks at a smaller share in Brazil than in most of the rest of the region.
Recent experience in Brazil shows that, while it may be hard to predict crises, swift and decisive action can deal with them. When Banco Santos, a middle-market bank, collapsed under massive fraud last year, the Central Bank quickly eased reserve requirements, while bigger banks stepped in to take lending off other middle banks’ books and ease an asset squeeze. This, says Mr Shaw, is the key to crisis management. “You can write all the laws you want,” he says, “but none of it matters if you’re not proactive in applying regulations.” That’s something many regulators in the region might bear in mind.
