Three years of underwhelming economic growth and a huge political scandal now in its fourth year have not had a downward drag on Peru’s banking system.
The country’s 15 banks racked up higher net profits in the year to November 2019 than they did in all of 2018, and return on equity was a strong 18.7% in November, up slightly from the end of the previous year, when it was 18.4%. Past due loans were at 3.05% in November 2019, slightly higher than the 2.95% at the end of 2018.
Regulatory strengths
Peru’s banking system has a list of strengths, including profitability, stability, asset quality and high liquidity. Analysts cite the country’s regulatory framework as one of the reasons Peruvian banks tend to outperform those in other Latin American countries: all banks in the system are well above local and Basel risk requirement standards.
If the past few years were good, the country’s banks are forecast to perform even better in 2020. Political tensions seem set to subside domestically, and international factors, including the trade dispute between China and the US, are cooling somewhat, helping to ease headwinds.
“Whatever the scenario, because there have been natural disasters, political scandals and years of mild growth, Peru’s banks have been resilient and earnings have always been strong,” says Valeria Azconegui, senior analyst and lead on Peruvian banks at Moody’s.
Tough environment
On January 14, 2020, the International Monetary Fund (IMF) published its conclusions following its Article IV consultation with Peru, which touched on the difficulties the country has faced in the past few years.
“A less benign external environment and adverse domestic factors have caused growth to lose momentum in recent years, and productivity has disappointed... The adverse 2017 El Niño weather event caused significant economic disruption and the findings of the Lava Jato [corruption] investigation hampered large investment projects,” said the report.
While Peru's banks continued to perform well in 2019, there is a widespread belief that if those pressures were remedied the banking system would grow at an even faster clip.
The problems mentioned in the report, however, are quite daunting and, while somewhat under control, continue to put a great deal of pressure on the Peruvian government.
Rebuilding from the rubble
President Martín Vizcarra’s administration is still looking to get a handle on reconstruction in the wake of rains and flooding caused by an unexpected coastal El Niño weather event in the first quarter of 2017. The National Civil Defense Institute calculated infrastructure losses at $3.1bn, or 1.6% of gross domestic product (GDP), that year. The government created an agency for reconstruction and prevention with a budget of $7.7bn, and planned to have work wrapped up in 2020.
Only a fraction of the work has been completed so far, and just 11% of the reconstruction budget had been used as of the third quarter of 2019. The slow pace of the reconstruction is symptomatic of public investment in Peru, which has been flat for the past two years. The Economy and Finance Ministry reported that only 66.2% of the investment budget across the three levels of government was used in 2019, the second lowest annual rate during the decade.
The state also has had difficulties with large investment projects, which has affected private investment and, as a result, corporate lending by banks.
Sergio Urday, head of economic information at Peru’s banking association (Asbanc), says there will be an uptick in corporate lending in 2020 as large projects get back on track and the economy picks up some steam. “We expect an acceleration in corporate lending as confidence increases,” he says. “Big projects will have an impact on both public and private investment.”
Lava Jato fallout
Confidence among consumers and the business sector has been shaken by continued political scandals, including the far-reaching Peruvian chapter of Brazil’s Lava Jato (‘car wash’) corruption investigation.
The scandal has halted a number of projects in Peru, including the $7.4bn southern gas pipeline and the $715m third phase of the Chavimochic irrigation project along the northern coast. It has also limited the options of many construction firms that have been caught up in the corruption investigation.
The scandal blew up in December 2016, when Brazilian company Odebrecht admitted in court to paying bribes to secure public works contracts in numerous countries, Peru included. The start of investigations coincided with the El Niño weather event, inflicting a double blow to the economy.
The Odebrecht scandal, still unfolding, has rocked Peru’s political class. All the country’s presidents since 2001 have been caught up, which resulted in Mr Vizcarra coming to power in March 2018. His crusade for political and judicial reform had created constant tensions with Congress until September 2019, when he closed Congress and called for new elections.
Growth worries
Domestic political battles and external pressures, including international trade tensions, affected Peru's economic growth in 2019. Though the economy expanded by 1.9% in November 2019, this was the third consecutive month that growth had slowed. The economy grew by 2.1% in the 11 months to November and the final figure is not likely to be much higher. The government had initially forecast 4% growth.
The IMF forecasts 3.2% growth for 2020, while the government forecasts 4% and the Central Reserve Bank (BCRP) 3.8%.
Ratings agencies, while closer to the IMF figure, do expect a recovery this year, reflected in stronger growth in the banking sector. “Peru will see economic reactivation in 2020, which will [come through] an expansion in personal and corporate loans,” says Andrés Marquéz, senior director of Latin American financial institutions for Fitch Ratings.
He adds that consumer loans will continue to lead, but that the expansion of loan portfolios will not create additional risks.
Solid system
Miguel Uccelli, CEO of Scotiabank in Peru, believes there is consensus among the country’s banks that 2020 will see an improvement on the previous year. He says the banking sector has historically expanded at about three times GDP growth, and this year will not be an exception.
“The potential for growth is high in consumer and corporate loans. Consumer lending will likely grow by double digits, while corporates should grow better this year because of indications of stronger private investment. Private investment is starting to show recuperation after two slow years,” he says.
The BCRP reported that total loans were up 8% in November 2019 compared with a year earlier. Corporate loans were up 7.8%, while consumer loans increased by 13%.
Mr Uccelli says that the system faces few problems, with all banks possessing solid capital ratios, high liquidity and assets well above requirements to cover risks. “There is not a bank in the system, large or small, that does not have a good international rating,” he adds.
He says Peru’s banks excel in the Camel rating system, used by regulatory banking authorities, an acronym that includes capital adequacy, asset quality, management, earnings and liquidity.
Strong governance
A key point for Peru's banks and analysts is the country’s regulatory system governed by the Banking, Insurance and Pension Superintendency and the BCRP. The two have played a central role in making sure Peru avoids a return to the late 1990s, when several banks faced liquidity problems and were forced to close.
“The sector learned from the previous crisis at the end of 1990s. The regulators require high levels of provisions for loans and all banks go beyond this. Non-performing loans [NPLs] are more than covered, which means that there are no surprises,” says Asbanc’s Mr Urday.
Peru’s regulations also set it apart from other large economies in Latin America, particularly in regard to NPLs. Under Peru’s rules, a corporate loan is considered an NPL 15 days after an interest or principal payment is missed. Other countries specify 90 days. Small and medium-sized firms are given 30 to 45 days, depending on the tenor, while personal loans become past due at the 90-day mark.
Mr Uccelli says that despite the strict regulations and slower growth, past dues have remained relatively stable even with the normal ups and downs of the country’s economic cycle.
“Past-due loans have been stable for years and we have not seen the upward trend that normally happens when economies slow down. The economy has been slowing, but past-due loans have stayed low,” he says.
Downing the dollar
In addition to how it categorises NPLs, Peru also has strict policies for writing off bad loans. Ms Azconegui says Peruvian regulations require banks “to prove that there is no way to collect on a bad loan, so banks tend to keep bad loans on the books longer than in other countries”.
Another recent improvement, and one the BCRP has been fostering, is the decline in loans and deposits in US dollars. Peru’s banking system was dollar dominated two decades ago, with deposits in dollars just shy of 80% of the total. Loans were nearly as high.
The change has been dramatic. Loans in dollars were 26.8% of total loans in November, down a point from a year earlier. Deposits in dollars were 37.1%, down from 37.8% from the previous November.
Mr Uccelli believes the decline in dollarisation is an important indicator. “Dollarisation was still a concern five years ago, when deposits in dollars were close to 50%,” he says. “We are now down to the lowest level since the economy was opened [in the early 1990s].”
Concerns and solutions
A few concerns have been raised about Peru's banking system, including the dominance of the top four banks, but the primary issue is the low level of financial intermediation or penetration.
Peruvians remain wary of banks and the financial system in general, and only about 40% of the adult population of 8 million use some kind of banking product. Peruvians are also still very much hooked on cash: only about 15% of the population use some kind of digital payment, according to a report from Visa in Peru.
A number of solutions have been tried, including a widely publicised electronic wallet, known as BiM, that involved the country’s banks, telecommunications companies and state agencies. While transactions have increased, the current thinking is that BiM is not the right approach for the country.
Part of the problem is the country’s high level of labour informality, but there have also been criticisms that the scheme has focused on the unbanked without first providing proper financial education, and that the state has not become as highly involved as expected, failing to use the system for subsidies paid out through social welfare programmes.
Asbanc’s Mr Urday says people who are unbanked, especially in rural areas, still have issues of trust with the financial system. He adds that part of the difficulties of BiM are “the lack of a personal contact that would help people better understand how it worked and the benefits of being bankarised”.
Although BiM has struggled, the country’s banks and financial start-ups in the system are poised to make major changes through digital services.
Among the advances has been the implementation of point-of-sale (POS) terminals that accept multiple brands and payments with QR codes. About 150,000 multi-branch POS terminals are in use in the country, and the number is set to grow in 2020.
Stuck in Congress
Peru's financial sector is also hoping that the country's first fintech legislation will be passed in 2020. The ruling was passing through the legislature in 2019, but was shelved along with other bills when Congress was closed. More than 100 fintechs are registered in Peru, with 31 used for payments, 26 as financing providers and 24 for currency exchange.
“Fintechs are going to help narrow the bankarisation gap step by step. It will not be very quick, of course, but there are a lot of initiatives for payment systems, foreign currency exchange, lending and factoring, which will contribute to financial inclusion,” says Ms Azconegui.
Digital payments services operated by banks are starting to make inroads, with three banks launching mobile apps in 2019. Banco de Crédito, the country’s largest bank, has Yape; BBVA, the second largest bank, has Lukita; while Interbank, in fourth place, has Tunki.
The big test will come halfway through the first quarter of 2020, when BBVA, Interbank and Scotiabank, the third largest bank in the system, launch a multi-bank payment app that will not require users to know account numbers to transfer money.
Mr Uccelli believes this will revolutionise payments. “Customers will be able to transfer money with only a phone number and not an account number. They will need to have an account, but will not have to provide the account number. It is going to facilitate small payments,” he says.
Fitch’s Mr Marquéz says that while the increase in financial intermediation has not been as rapid as banks and the authorities had hoped, Peru is heading in the right direction.
“The big banks are focusing much more effort on digitalisation, expanding products and becoming more efficient,” he says. “This is going to help with bankarisation the way it has in other countries.”
