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AmericasNovember 24 2010

Uruguay's banks being crippled by caution

As governments in the Western world attempt to implement more conservative regulation within their financial markets, banks in Uruguay are stagnating because of the country's overcautious economic approach over the past decade. Writer John Rumsey
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Uruguay's banks being crippled by cautionA change for the good? a large crowd of supporters of the ruling Frente Amplio party surround a security group escorting newly sworn-in Uruguayan president Jose Mujic, in March this year

Pint-sized Uruguay has successfully cleansed its banking system of Argentinian deposits and loans since the disastrous crash of 2002 and its banks are well cushioned and reserved. Yet, in spite of a rash of takeovers by large foreign banks, the sector remains curiously undynamic. Levels of lending are trifling, particularly to corporates, capital markets are moribund and the development of long-term lending is painfully slow.

During the second term in government of the left-leaning Frente Amplio party, which retained power in March, the government will be legislating to nudge banks to serve more of the population and lend more to meet long-term infrastructure needs and social objectives. However, it needs to tread carefully not to deter foreign banks altogether, for whom tiny Uruguay is not a major priority.

Macro background

The good news is that Uruguay's economy is performing well. Gross domestic product (GDP) growth is expected to be about 8% this year, well ahead of earlier official projections, says Fernando Calloia, president of Uruguay's largest bank, the state-owned Banco de la Republic Oriental de Uruguay (BROU). He adds that GDP is expected to maintain a healthy growth of 4.5% in the following few years. Ricardo Marino, vice-president of foreign banking at Brazilian bank Itaú Unibanco, which has business interests in Uruguay, is somewhat more cautious, but even he predicts 6.5% economic growth this year and 4% in the following few years.

The super-commodities cycle that has bumped up neighbours Brazil and Argentina has also given Uruguay's agricultural sector a shot in the arm. The stability of its regulations and openness of the economy continue to attract foreign investment.

"The government has pursued the right policy for economic growth over the past five years," says Mr Calloia. Growth has been high, inflation has stayed at about 6%, low compared to previous periods, and the fiscal deficit has been reduced, he adds.

The government is also pushing to diversify its economy. "We are the most open country in South America and have been growing in services, software, logistics and outsourcing. One-third of our exports today are [in] services and the growth rate is higher than other sectors," says Fernando Lorenzo, minister of economy and finance. "We are in a good position to enjoy many benefits from the new international situation."

Even so, the economy is still too dependent on agriculture and competitiveness needs to be sharpened. "We need to implement transformations in infrastructure, qualification of the workforce, education and many aspects that lie at the core of competitiveness. We could do better in many fields related to competition, innovation and infrastructure," says Mr Lorenzo.

Continuity, not change

The strong economic growth enjoyed during the term of the previous administration, and Frente Amplio's re-election for a second five-year term, means the buzzword in Montevideo's political scene is 'continuity'. Indeed, although there have been musical chairs for key economic positions, the main political players have not changed.

The continuity message is important because president José Mujica, who took office in March, was not supported during campaigning by his popular predecessor Tabaré Vázquez. Mr Mujica was a guerrilla fighter against Uruguay's right-wing government during the 1960s and 1970s, making some nervous about his policies. In a region where political change is often extreme and legislation regularly overhauled, Uruguay has been a model of stability and that has always been its most precious commodity.

"In our first term, we were a socially oriented administration. That is not to say that we are populist or imprudent. We've proved to be a very responsible administration," says Mario Bergara, president of Uruguay's central bank.

Already, 70% of the government's total spending is channelled towards social programmes and the focus on cutting poverty will continue, says Mr Bergara, who adds that poverty was almost halved under the old administration to 20%.

Nevertheless, there are new emphases in economic policy, particularly on security, housing and infrastructure, and with regards to the latter, banks will be key in supplying the long-term financing.

Too much caution?

Uruguay was long at the mercy of Argentina's mercurial economy, and since the 2002 economic crisis in Argentina impacted greatly on Uruguay, prudence has been the watchword.

In December 2001, just before the crisis that led to Argentina's devaluation and debt default, more than 40% of deposits in Uruguay were held by Argentine residents. Today, that figure is 17% and other non-residents make up just another 3% of deposits. Much stronger supervision and restrictions on lending have led to a more prudent banking system, and capital ratios today are a very conservative 17%.

The growth of the country's economy has slashed non-performing loans (NPLs) and many companies have been able to pay down debt in the past few years. Those that had US loans have been helped by the stronger peso as well.

NPLs represent about 1% to 1.5% of Uruguay's banking system and counter-cyclical provisioning, similar to the system in Spain, means banks need to hold reserves worth 7% of loans, says Mr Bergara.

Supervision was restructured in 2008 with the end of self-regulation, which had caused problems, and the creation of a superintendency of financial services, says Mr Bergara. The new, centralised supervisor is responsible for all of Uruguay's financial markets: banks, insurers and pension funds, he adds.

So far, so good. Yet, although fundamentally stronger, Uruguay's banking sector has been stagnant or even in decline in terms of new business and profits, says Ana Pereyra, director at AMP Financial Advisory Services in Montevideo.

"We expected to see a little more activity in recent years but it has actually fallen," says Ms Pereyra. "The imposition of a personal income tax of 25% in 2007 is applied across the board, even a maid pays it. With average salaries of between $500 and $1000 a month there are fewer savings," she adds. The sector has never been particularly profitable, especially as Uruguayans can invest inside or outside the country, adds Ms Pereyra. Higher real peso salaries have remorselessly driven up costs for banks, especially as most have income from US dollar streams, in which most lending and deposits are carried out.

Weak demand for corporate credit means such lending is not extensive or profitable, and low profits mean banks offer depositors few incentives, making savings accounts unattractive. Lack of demand for bank services has kept spreads very tight and the corporate sector unprofitable for them. Strict supervision and high provisioning levels add to the general torpor in the sector.

Deposits are more than twice the amount of credit, says Mr Calloia. Structurally, there is an insufficiency of demand, he adds. Also, most companies are family-owned and used to self-financing and reinvesting profits, says Mr Bergara.

That has banks looking to consumer credit, also an under-developed area. Credit to GDP is rock-bottom at 25% and this area will be the driver for growth in the Uruguayan banking sector, says Mr Bergara. There is still a long way to go to meet consumer demand for credit, agrees Ms Pereyra, adding that as this is the only decent source for profits, all the banks are following the same strategy and rates are coming down just as competition heats up.

Decades of consolidation

The 2002 crisis and lack of profitability have led to huge consolidation. The number of banks has fallen from 25 at the time of the crisis to just 14 banks today, of which only seven or eight are particularly active, according to Ms Pereyra. Moreover, BROU accounts for some 45% of the market and Santander a further 25%, making the sector too concentrated. If there were a problem with any of the country's top three banks, it would infect the whole system, she adds.

"Our banking system is very simple," says Mr Bergara. Yet he is not concerned the system is too consolidated. "The public bank sector is not at the peak of market share historically and Uruguay is a very small market making five or six banks with significant market share reasonable." Stronger foreign banks with deep pockets and know-how may actually bring more competition to the system, he adds.

The largest acquisitions in Uruguay were made by Spain's Santander and BBVA. The former bought the operations of ABN Amro in 2008 as part of a Latin America package, but Brazil was the chief draw for the bank, not Uruguay. Spreads in Uruguay are thin whereas Brazil has some of the highest spreads in the world. This year, BBVA took over the operations of Crédit Agricole, which has 36 branches in the country.

These mergers are still being digested, says Mr Pereyra, who finds that service has generally got worse at all the merged banks as they get to grips with different business models and systems.

A final problem remains the prevalence of dollar-based lending and deposits in the country. The dollar may have fallen over the past seven years, making peso deposits a better bet, but Uruguayans have remained firmly wedded to the greenback. A deep-rooted fear of inflation that has destroyed monetary value in the past has prevented evolution of deposits and lending in the peso market, says Mr Calloia. About 80% of corporate lending is transacted in US dollars, he adds.

Mario Bergara, president of Uruguay's central bank

Mario Bergara, president of Uruguay's central bank

Mario Bergara, president of Uruguay's central bank

New proposals

As banks in Uruguay struggle to integrate acquisitions and make profits on the slim pickings available, the government is figuring out how to extend banking services.

"We need to improve financial inclusion, extend bancarisation and bring services to the public and firms. Banks needs to be more active in terms of deposits and credit. There is a lot of space and opportunities to expand and improve our banking activities," says Mr Lorenzo.

To that end, the government is introducing new regulations and a legal framework to encourage the use of banks as a financial intermediary, such as making the payment of wages and tax obligations electronic.

Itaú Unibanco is one bank making an effort in this direction. The bank will expand its branch network from 18 to 25 by the first few months of 2011.

The government has put together a task-force that brings together the banks, the Ministry of Finance and Economy, financial institutions and workers to prepare a set of suggestions for legal changes to the system in areas such as tax and regulation, says Mr Bergara.

More risk please

As the rest of the world reins in on lending, Uruguay's ossified banking system is looking to be a little less cautious. When asked if banks are too conservative, Mr Bergara laughs and says: "Yes, absolutely. In the crisis of 2002, everyone - regulators, bankers, managers, companies and families - became more conservative." This was the first crisis in Uruguayan history where depositors lost money, he adds.

The moment is ripe for the supervisor to allow more flexibility with reserves at a staggering 70% of capital, says Mr Bergara. "Having seven out of every 10 dollars in their pocket means that banks are not fulfilling their role," he adds.

He cautions that banks should not expect a blanket break, but carefully thought-out regulations that tie the loosening of supervisions or better tax treatment with real results, such as expanding Uruguay's very low number of points of sale for debit cards or extending internet and mobile banking, he says. "If we make regulations looser, we need to balance bancarisation with security," he adds.

The question is, with so many other areas of growth in the region and frugal levels of capital for investment, will foreign banks really be interested in investing in low-profit Uruguay, particularly in bancarisation?

Fernando Lorenzo, Uruguay's minister of economy and finance

Fernando Lorenzo, Uruguay's minister of economy and finance

Fernando Lorenzo, Uruguay's minister of economy and finance

Long-term planning

If Uruguay's government is successful in persuading banks to offer more services, it would help with another cherished aim. A serious issue is the banks' long-term lending. With a rip-roaring economy and government plans to boost infrastructure to keep up with growth, the re-emergence of peso-denominated capital markets is becoming essential.

The government is getting a new law on public-private partnerships passed to attract in private and foreign investments. Private equity firms could be one rich source and are already present, and capital markets would help enormously.

The good news is that the government is no longer crowding out such investment. There has been a significant drop in public debt as well as the development of a peso-denominated market.

Today, gross debt is some 40% of GDP, compared to close to 110% at the time of the crisis. At that time, all the debt was dollar-denominated and today nearly 40% is in pesos or in inflation-indexed units, says Mr Bergara. The government will keep pushing the development of the peso market issuing in local currency, he adds.

Uruguay's debt profile is comfortable and over the next 10 years, just 1% of GDP will be spent on amortising debt, says Mr Bergara. That has driven down yields and even though Uruguay remains speculative grade, "we are comfortable that the market has given us an investment grade, looking at our country risk", he adds.

That opens space for long-term infrastructure financing with institutional investors and banks expected to play their part. The government and BROU have set up a guarantee fund to get the market off the ground, says Mr Calloia.

Pension funds too should play an important role. Today, they represent 18% of GDP and each year assets are growing by 2%. Traditionally, they have invested heavily in government paper, but as the debt profile improves and assets grow, they should turn to riskier assets, such as infrastructure, says Mr Lorenzo. The airport that has recently opened in Montevideo was built with private public monies, he notes.

But Mr Bergara accepts that the challenge is to financially engineer such projects to make them attractive and understandable to institutional investors.

Optimism when it comes to Uruguay's prospects is well placed as the country enjoys a boost from its agricultural sector and takes advantage of its enticing investment laws and stability in a region that is booming. To maximise the potential from this golden era, the government needs to make sure it sets out clear priorities and persuades banks that they can make decent profits at the same time as they reach out to under-banked parts of the country.

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