An economic boom coupled with new technologies is allowing Peruvian banks to tap consumer bases that have long been overlooked in the country. But, as the banking market advances at a breakneck speed, there are vulnerabilities to look out for – not least dollarisation.

Banco de Crédito del Peru’s headquarters, in the country's capital Lima, oozes wealth. Outside of the building, in the desert climate of the city, an artificial waterfall cascades into pools bordered by tropical flowers. Inside, the walls are dotted with pre-Columbian art, just a small part of a much larger collection.

Banks throughout the country are riding Peru's buoyant economy, trying to catch up with their counterparts in the rest of Latin America. A number of factors are in their favour: a strong gross domestic product (GDP) and investment outlook, a woefully underbanked population, a small number of large banks, and fast-growing capital markets.

Low interest rates and record employment underpin strong GDP growth, which came in at 8.8% in 2010 and has been a steady 6% to 7% since then, according to Jeanne Del Casino, group credit officer of Latin American banks at Moody's.

Standard & Poor’s also has a positive outlook on the BBB rated sovereign. According to Sergio Garibian, the senior director of banks in Latin America at Standard & Poor’s in Buenos Aires, the Peruvian economy has become substantially more diversified and the country is starting to tackle institutional weaknesses.

Cautious optimism

Inside the country's banks, optimism is high. Walter Bayly, CEO of Peru’s largest bank, Banco de Crédito del Peru (BCP), says that most economists are forecasting GDP growth of about 6% for the next few years, although he is cautious of volatility. “My [gut feeling is to not] quite believe the economists. Straight-line growth very rarely occurs," he says.

What could upset the forecasts? With 2% of GDP growth coming from mining investments, a major downturn in commodities prices would hurt. Politics, too, might come into play, though investor concerns that the country's president, Ollanta Humala, who came to power in 2011, would intervene in the economy have proved largely unfounded.

According to Mr Bayly, the president “does not have a tremendous ideological position”. But nagging doubts remain. The government got close to buying a stake in the country’s largest refinery, La Pampilla, and a chain of service stations from Spanish Repsol, although it shelved plans after an investor outcry. Nationalisation is a fear. “We have a track record of being very poor managers of public sector assets,” says Mr Bayly.

Innovating lending 

The most likely scenario is fast GDP growth and stability. Even by Latin American standards, Peru has low levels of bankarisation, 34% compared to 43% in Brazil and 60% in Chile. Domestic private sector credit also trails the regional average at just 26% of GDP, compared with 61% in Brazil and 71% in Chile.

This means that Peruvian banks are now flexing their muscles. “The financial system will double in size in the next five years, experiencing 15% annual growth,” says Mr Bayly.

Where that growth will come from is up for debate. According to Eduardo Torres Llosa, joint general manager at BBVA Continental, much of the growth will happen outside the main centres of Lima, Arequipa in southern Peru and Trujillo in the north. Ms Del Casino at Moody's predicts that the growth will flow to the four largest banks, which already own some 75% of assets and deposits. These banks are diversifying their delivery channels: opening branches may remain important but it is ATMs, in-store banking and mobile technologies that will help unearth lower income consumers.

BBVA Continental has 300 branches today; it had fewer than 220 four years ago. But in the past three years, the bank's number of ATMs has doubled, and in-store sales points have tripled over the same period. The pioneering frontier remains in mobile banking, where BBVA Continental is building a new platform for smart and non-smart phones, according to Mr Torres Llosa. He predicts that in five years, 15% of all operations in the Peruvian banking system will be phone-based, versus some 6% today.

BCP is innovating, too. It has started deploying an alternative to the ATM through a machine that enables a store owner to provide the cash to the consumer and then be repaid by the bank. It is a technological development that saves lots of money. “At $4000 apiece, these machines are a lot less expensive to operate than an ATM, which costs between $25,000 and $30,000. We have 5700 of them,” says Mr Bayly. Advancements such as these make him confident that the bank's customer base will grow at about 20% a year.

Developing credit

In a system that is still focused on bread-and-butter products, credit has been the growth area for Peru's banks, and they admit that things need to cool down a little. Mr Bayly says that consumer and mortgage credit at his bank was growing at more than 25% in both segments in 2012, and will be trimmed to between 18% and 20% this year.

The past-due loan ratio reached 1.85% in January, up 0.31 percentage points year on year. But past-due loan numbers are small compared to other countries in Latin America and worldwide.

Banks are increasingly cautious with new customers. Rates start as high as 45% a year, but quickly come down as customers build a track record, says Mr Bayly. Lenders are also using statistical models, which are helpful but, as Mr Bayly admits, imperfect. “No country has developed credit without stumbling,” he says. “You have to build models based on data from other markets and consumer groups. You hope and pray that they are valid for new consumers."

BCP started seeing some deterioration in portfolios in mid-2012 and tightened up. Mr Bayly says that default rates on new loans are lower.

Default rates are a concern for Mr Torres Llosa at BBVA Continental, too. “We have been a little bit concerned by default rates. We have to keep in mind that we are in the upside of the cycle and so witnessing an increase in past-due loans is worrisome,” he says, adding that there is some over-indebtedness in subprime sectors and among higher income earners, which he puts down to some banks having been too aggressive.

A year ago, credit in the Peruvian banking system was expanding at 18% to 20% year on year, but this year Mr Torres Llosa expects that to taper to between 12% and 15%. Mr Bayly sees the entrance of retailers into this market as a challenge to banks. He says that retailers such as Falabella and Ripley are giving banks a run for their money with very low costs of acquiring new cardholders.

Ms Del Casino believes that with more than 6% net interest margins, Peru has one of the highest levels of profitability in the region. Mr Bayly identifies one sector, in particular, that will increase profitability. He says that the mortgage sector will continue to grow in coming years at close to three times the growth in GDP, or 15% to 18%. “Projects get sold as fast as they can get built,” he says.

BBVA Continental has also identified this sector for its growth potential. It is focusing on social housing, where the government is under pressure to step up building fast. “The government is financing about 20,000 new homes per year. That is completely insufficient – we need about 100,000,” says Mr Torres Llosa.

Dollarisation damages

While growth in the mortgages sector is of great appeal, dollarisation is a worry to bankers. “Dollarisation of the economy is one of the major vulnerabilities of the Peruvian baking system,” says Mr Torres Llosa.

Mr Garibian at S&P also expresses concerns over the dollarisation of Peru's economy. He says that there are pockets of lending where it is proving hard to wean consumers off dollars, particularly mortgages to higher income consumers. To fuel these dollar mortgages, Peruvian banks are borrowing heavily in overseas markets. In 2012, issuance overseas by commercial Peruvian banks grew by 48% compared with 2012, and tripled from 2007, reaching $10.5bn. That creates a risk that Peruvian banks become dependent on dollar funding.

“We accelerated borrowing this year and have already pre-funded our needs,” says Mr Bayly. “The market is there at good rates thanks to low country risk and appetite for emerging market bonds. That might change.”

Peru has made strides in reducing the persistent dollarisation of the economy. In the early 1990s, some 90% of deposits were dollar-based and that has come down to 39%, says Mr Bayly. Authorities have been discouraging dollar loans and the superintendency of banks has made banks attach more capital to dollar mortgages.

BBVA has seen mortgages in US dollars decline from more than 50% just 18 months ago to about 30% today. The bank is granting fixed-rate 20-year mortgages in soles, a product that it did not offer a couple of years ago, says Mr Torres Llosa. Even so, he notes that in terms of the stock of mortgages in the system, dollar lending is still high at 50%.

Expansion efforts

If the consumer market is growing in leaps and bounds, Peruvian companies are increasingly turning to international and domestic markets to fund themselves. “Banks are being disintermediated from the flows of the large corporates, which are going to the domestic and international markets,” says Mr Bayly. Mr Torres Llosa predicts that corporates will issue $8bn to $9bn this year, a significant advance on the $5.8bn issued in 2012, itself a record year.

As Peruvian corporates tap capital markets, banks are building an investment banking presence and looking to capitalise on the development of the Latin American Integrated Market (MILA), which seeks to encourage capital flows between Colombia, Chile and Peru.

BCP has spun off its domestic investment bank and bought franchises in Colombia and Chile. “We are doing exactly what consultants say not to do: a three-way acquisition,” says Mr Bayly. He adds that the exponential growth potential makes the move worthwhile. The bank is also eyeing investment banking opportunities in Mexico, which is also slated to join MILA. 


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