Foreign banks must cherry-pick less to avoid Latin American wrath

The arrival of foreign banks in Latin America – to the point where in some countries they own a majority of the banks – has led to solid, solvent banking systems. There is one problem, though: they are not doing their job. And an outcry about this is beginning that could lead to legislative change.

Have countries in which foreign banks have established themselves benefited? Not as much as they could have if, as we believe, a bank’s main role is to channel money from depositors to consumers and businesses to make an economy grow and prosper, as long as this allows the banks decent returns. This is especially true of Latin American markets, where other sources of finance are scarce.

Not enough credit

In its report, Unlocking Credit: The Quest for Deep and Stable Bank Lending, the Inter-American Development Bank (IDB) noted that in the 1990s the average level of credit to the private sector in the region was only 28% of GDP. And this was significantly lower than in other developing regions, such as east Asia and the Pacific (72%) and the Middle East and north Africa (43%).

There are a number of reasons for this, but the fact that Latin America has among the largest proportion of banks under foreign ownership – 85% in Mexico, for instance – is relevant.

The nub of the issue is that many banks can achieve higher profits through commission income and investment in government securities. That the Venezuelan banking system should have had 1.5 times more stock and bond holdings (mainly public debt) than private credit in 2003 is hardly surprising due to the volatility of the political situation. But it is harder to justify why Mexico, with its more stable growth patterns and the North America Free Trade Agreement, should have a banking system in which 45% of total claims in 2001 were public debt (according to IDB calculations based on IMF data), even though some of that was leftover from a bail-out some years before.

And the foreign banks are more at fault. The report says that in Mexico, for instance, foreign banks have 2 percentage points more public debt on their balance sheets than local private banks.

A few months ago, Mexican central bank governor Guillermo Ortiz pointed out that, in an environment of stable prices, banks’ profits should come mainly from extending credit. This criticism is expressed privately by many more Latin American central bank governors, who also complain about the high fees that customers are charged.

The banks argue that the lack of good credit bureaux and efficient judicial processes are responsible.

Interference in store

Should banks be worried? Moves are afoot in Mexico to legislate – and when a free-market champion like Mr Ortiz starts suggesting he might use his authority to change the regime for foreign banks, they should take notice. With left-leaning governments in power in the majority of Latin American countries and a discredited Washington Consensus, the chances of regulatory interference are increasing.

Tips can be picked up from other countries on how regulation can modify the situation without making banking unattractive to foreign banks. India, for example, has a rule that 18% of total loans should be to the agricultural/rural sector. Brazil still has mandatory credit allocations to sectors such as housing and agriculture. This may sound old-fashioned – harking back to inefficient state banks – but it can be done productively. Even the US legally forces banks to lend money to lower-income people in the areas where they operate.

An untested model in transformation and self-regulation is South Africa’s Financial Charter. Agreed voluntarily by the financial sector and endorsed by the Thabo Mbeki-led government in late 2003, it set out detailed empowerment targets for companies. Among them was expanding financial services to low-income households and unlocking about $7.5bn for the financing of black-owned businesses. Barclays, notably, announced the acquisition of Absa, one of South Africa’s big four banks this year, proving that foreign banks had not been scared away.

Cherry-pickers

Banks are the linchpins of the economy in developing countries and, administered well, banking licences can be licences to print money. Cherry-picking the best bits of business in these countries looks as if it is becoming unacceptable to the authorities as they search for ways to grow their economies.

Foreign banks in Latin America should grasp the nettle if they want to ensure that they have an input and a chance to moderate any proposals made. Otherwise, they will need to be ready for long battles in which all sides will lose. If they act now, they will help local economies grow while also safeguarding their profits – which, ultimately, will be beneficial to all concerned.