Back in the black

The Dominican Republic has made great strides in restoring public confidence in the country’s banking system. The 2003 banking crisis was almost a textbook case in rampant embezzlement, fraud and mismanagement, all coming together to bring about the collapse of Banco Intercontinental (Baninter), the country’s third largest bank.

This sparked a huge increase in the quasi-fiscal debt, sustained depreciation of the Dominican peso, sharp increases in the cost of living, and stagnation of salaries while jobs were being lost. Two large insurance companies were de-capitalised and went under in this period.

The government was forced to launch the largest depositor bail out in the country’s history. Customers of two other smaller collapsed banks were also part of the bail out operation. The crisis is estimated to have cost the country an unprecedented 20% of gross domestic product (GDP). In the wake of this disaster, the government moved to improve a long-overdue tightening of supervisory practices and strengthen the regulatory framework, including the adoption of consolidated accounting and supervision.

The emphasis was on ensuring that all banks comply with the phased implementation of asset valuation and capital adequacy norms based on international best practices.

“The government must devise a medium-term plan to re-capitalise the Central Bank and permanently reduce its quasi-fiscal deficit,” says Standard & Poor’s analyst Richard Francis. “The government is expected to raise money to address this re-capitalisation task, while the Central Bank is expected to continue its divestiture of non-core assets as well.”

Under the International Monetary Fund (IMF) agreement, the country will receive 200% of its IMF quota, or $670m, to be paid to the Central Bank to strengthen its reserves position and the balance of payments. The application of the programme opens doors to fresh resources totalling an estimated $2.7bn. Funds are also expected to be forthcoming from the Inter-American Development Bank, and as a result of foreign debt re-structuring and direct disbursements from the IMF.

Bumper growth

Following the successful completion of the IMF agreement and the gradual restoration of public and international confidence in the financial sector, the country’s banking system has been experiencing very strong growth over the past few years, characterised by a diversification and modernisation of services. The biggest chunk of the financial sector remains in state hands.

There are basically seven banks that matter in the Dominican Republic, with the government-owned Banco de Reservas being the country’s largest retail player, with more than a third of market share. In common with its peers, the bank has benefited from lower funding costs, while an expanding economy helped to boost demand for consumer credit.

Daniel Toribio, the CEO of Banco de Reservas, one of the two key domestic banks on the island.

The persistent problems of higher operating costs, and in particular the need to set aside significant loan loss provisions, has brought pressure on operating profits, which grew 1.7% in 2006, slightly below the previous year’s 1.9% level. The banks are taking no chances in the wake of the financial crisis that rocked the system a few years ago. Banco de Reservas’ loan loss provisions cover more than 107% of total impaired credits, defined as past due and restructured loans.

Banco Popular has shown a solid rebound in lending, with near 30% growth in its loan portfolio last year, the largest increase of all domestic retail banks. This positive trend was supported by a 13% drop in past loans due in the same period. As a result, the bank was able to manage its bad debts to total loan book ratio down to 2.3%, the lowest of the sector. Loan loss reserves covered more than 200% of past loans due and 140% of total impaired loans. Despite the increase in operating profit to average asset to the highest level amongst its peers, heavy pressure on overheads and loan loss provisions resulted in a stagnation of return on average assets at 2.1% last year.

Banco BHD enjoyed a buoyant year after a major overhaul of its risk control systems and the development of innovative new products. The loan portfolio was boosted almost 24% following the acquisition of the consumer business of Republic Bank of Trinidad and Tobago. Past loans due fell by 36% thanks to the bank’s efforts to recover troubled loans. The ratio of past loans due to total loans fell to 2.9%, compared with a 4.5% market average, while loan loss reserves stood in excess of 230% last year.

Banco Léon has emerged from a three-year programme to overhaul its financial profile and has posted significant advances in asset quality ratios and operating profits. Despite the positive trends, a rescheduling of payments of a group of loans resulted in an increase of restructured credits up to 6.7% of the bank’s total portfolio. The bank is following a conservative dividend policy that should bring an improvement in its capitalisation ratio, needed to enhance its financial profile and provide greater flexibility ahead of expected strong growth in consumer credit demand.

Overseas players

Foreign banks operating in the Dominican Republic are conspicuous by their absence, a fact that could entail some disadvantages in terms of future competition with the implementation of the DR-Cafta free trade agreement with the US. Republic Bank (DR) began a re-structuring process in 2003 when Republic Bank of Trinidad and Tobago acquired the majority of the local bank’s shares. The domestic bank then decided to downsize its operation in the country, concentrating on the corporate and trade finance markets, with the sale of its branch network and consumer and business portfolio to Banco BHD.

Republic Bank (DR) intends to improve its operating results through lower overheads and significantly less provisioning requirements that would compensate narrower margins given its new corporate orientation, while non-recurring income will reduce its weighting in net income.

Citibank sold its Dominican consumer and retail portfolio last year to Scotiabank, making the Canadian bank the only foreign player with a full-service consumer business in the country. Scotiabank has been operating in the Dominican Republic since 1921, making it the oldest bank in the country with an unbroken record of presence.

“The Dominican Republic is an integral part of our bank’s Caribbean strategy,” says country representative Joe van Dongen. “We had a relatively modest presence until 2003, when we acquired selected assets from the failed Baninter, which boosted our retail network to 58 branches.” In that year, Scotiabank bought Baninter’s credit card portfolio, a small number of retail loans and 39 branch offices. This enabled Scotiabank to grow its market share to 10% of the banking system’s total assets.

“Until 2003, our focus was more on the corporate end of the business,” says Mr van Dongen. “We now have a more balanced business mix and most of our resources are in the retail sector. We are looking at opportunities to expand in the SME [small and medium-sized enterprise] and mid-cap corporate market.”

Mr van Dongen points to a dramatic improvement in the country’s economic indicators over the past three years, highlighted by a revaluation of the currency supported by a reasonable inflation rate. “GDP growth has resumed more normal levels, beyond what the government had forecast,” he says. “The important thing is that this is a business-friendly government that has restored people’s confidence, thanks to the successful completion of the IMF standby arrangement.”

Obstacles to entry

However, the Dominican Republic is not an easy market for a foreign bank to enter, he says, given the dominant position of the two large domestic players, Banco de Reservas and Banco Popular. “Nevertheless, I believe there will be consolidation over the next five years,” he says.

Scotiabank has brought in some new initiatives to take advantage of the country’s improved economic position. The bank launched its Scotia Private Client Group last September, aimed at upper tier and some middle-tier clients, with wealth indicators of $100,000 to $1m. The bank has an insurance subsidiary operating in the Dominican Republic and Mr van Dongen says they are looking at ways to take advantage of the insurance market with new products in areas like auto, life and health and disability insurance.

“Clearly, the Dominican Republic has weathered the worst of its financial and economic crisis and has begun to witness solid growth similar to its halcyon days of the 1990s,” says Standard & Poor’s Mr Francis. “However, to put the country on a sustainable path to improved creditworthiness and continued high economic growth, several institutional reforms in the areas of electricity, the financial sector, debt management and fiscal policy are needed. The passage and implementation of these reforms will be key for positive ratings actions going forward.”