Political and economic stability set to sustain Peruvian banks' growth

Peru’s new president, Ollanta Humala, who took office on July 28, faces two key challenges, according to government officials, bankers and regulators.

The first is to sustain Peru’s high economic growth rates and good macroeconomic performance in a difficult international situation, with the risk of another recession in the US – one of Peru’s main trade partners – and of eurozone financial turmoil.

Second, there is the internal challenge of how to fulfil Mr Humala’s mandate to reduce poverty, which now affects 31% of Peru's population, and increase social inclusion when the country's central bank, Banco Central de Reserva del Peru, forecasts gross domestic product (GDP) growth of between 6% and 6.5% in 2011, which though high compared with developed countries, is down from the 8% to 9% rates enjoyed by Peru for most of the past five years.

Banking salvation

But a key asset in such potential storms is Peru’s banking sector. According to the International Monetary Fund’s assessment, Peru has the best regulated banking sector in Latin America. The industry also proved resilient in the 2007-09 global financial crisis and is well cushioned to face external problems again, says Julio Velarde, who was recently appointed for a second term as central bank governor by Mr Humala.

The sector itself is small, consisting of only about a dozen banks, and just four of them accounting for 84% of the system's credits, deposits and assets as of August 31, 2011, according to Peru's national financial regulators, the Superintendencia de Banca y Seguros (SBS).

The four banks are Peruvian-owned Banco de Credito del Peru, or BCP (the biggest by assets but fourth in terms of operational costs as a percentage of total revenue, a ratio of efficiency); Spain’s BBVA-owned Banco Continental (the second largest but the first according to the same efficiency ratio); Canada’s Scotiabank Peru (third in assets, second in efficiency); and the Peruvian-owned Banco Internacional del Peru, or Interbank, (fourth in assets and third in efficiency). These rankings are based upon SBS data as of August 31.

Peru's 'big four' banks have different business models. BBVA’s Banco Continental, which, together with BCP, is the biggest lender to large and medium- sized businesses, is number one in trading government debt and in capital markets, for instance. Scotiabank is the biggest of the four in credit cards and, with Interbank, focuses more on retail banking. Meanwhile, in the year to August 31, 2011, 68% of the system’s entire lending went on small, medium and large businesses. Consumer credits, principally credit card lending, accounted for 17% of total credits, and loans for mortgages accounted for 15%, according to SBS. 

But, according to national regulators, it is proof of the system's strength that the industry had an average non-performing loan rate of only 1.5% as of June 30, 2011, and an average 13.55% capital adequacy ratio, higher than both international standards and the requirements of SBS.

Reserve requirements

Peru also introduced cyclical reserve requirements at banks in 2008 – which Basel III regulators are only now beginning to recommend. "Though about 45% of the [sector’s] loans are in dollars, this [dollarisation] does not pose the same risks that faced the banking system in eastern Europe, where the funding came from abroad. Here the depositors are local,” says Mr Velarde.

He adds that Peru has “more ammunition in monetary policy” than in many other countries.

For instance, the central bank’s interest rate is now 4.5%, which can be lowered. Peru also has close to $50bn in international reserves, equivalent to almost 40% of the country’s GDP (estimated at $172bn this year), more than five times short-term foreign obligations and 92% of the financial system’s liabilities with the private sector. And recently introduced reserve requirements for dollar deposits and short-term loans in dollars can also be lowered “pretty strongly, providing banks suddenly with a lot of cash, which they are forced to put to good use”, Mr Velarde says.

Meanwhile, credit grew an average of about 20% a year from August 2006 to August 2011, more than double the rate of economic growth; and over the same five-year period, return-on-equity ratios averaged 17% to 25% and return-on-asset ratios were always above 2%, according to SBS.

Governmental continuity

On top of all that, President Humala has moved quickly to reassure financial markets and businessmen who feared his documented admiration for Venezuela’s Hugo Chavez might lead him to adopt far-left policies. Instead, the early signs are that Mr Humala's policies will more closely resemble Brazil’s moderate social democracy, and his cabinet includes many independents as well as a liberal economic team. The new finance minister, Luis Miguel Castilla, who holds a PhD from Johns Hopkins University in the US, was deputy finance minister in the outgoing conservative government, providing continuity.

“We want to keep the economy growing at, at least, 6% – notwithstanding the fact that there is a potential storm in the external environment – and doing so with macroeconomic stability, which has been one of the main assets that [Peru has] developed over the years,” Mr Castilla said in an interview with The Banker at the IMF/World Bank annual meeting in Washington at the end of September. The government’s first budget, presented to Congress in September, is fiscally prudent, most observers say, with about 10% of ordinary budget resources reserved as a contingency that may be used in a stimulus programme if warranted by the international situation.

Mining tax

Meanwhile, fulfilling a campaign promise – and balancing the interests of investors and communities – Peru's government has reached an agreement with mining companies under which they will pay an additional tax on profits totalling about $1bn a year over the next five years.

Senior government officials have said the new tax will not affect planned investments of about $30bn over the next five years in the country's mining and energy sectors and infrastructure. In response, mining companies, which include several multinationals, have announced that they are relieved the tax was not more onerous and that Peru will remain competitive with countries such as Chile as an investment destination.

Another purpose of the tax is to meet the needs of Peruvian regions not endowed with natural resources, and to reduce social conflicts, which have risen sharply despite the country's booming economy. The tax was considered a key issue as many believed that the wealth from the mining industry could be wider spread across Peru.

Positive reviews

“So far all the moves the government has been making have been the right ones. Even the new tax on mining companies…. everything was done quite well. It was done intelligently,” says Walter Bayly, CEO of BCP, the country’s biggest bank. “But one cannot be blind to the fact that [Mr Humala was], several months ago, [espousing totally different views].”

Carlos Gonzalez Taboada, CEO at Scotiabank Peru and special advisor for  Scotiabank throughout Latin America, is more positive. “In general, I think the government is sending the right signals to the private sector, wanting to increase economic growth, keep a fiscal balance but spend some resources to cover social needs. That is good for everyone,” he says.

In a further sign of confidence, he adds that Scotiabank is planning to invest $40m in 2012, largely to expand the bank’s distribution network for middle- and lower-income markets. Twenty percent of the network growth will be in correspondent banking; and the Canadian bank also plans to make its ATM franchise the third biggest in Peru – at present it has 500 ATM machines.

The bank also plans to open a new branch in an affluent Lima neighbourhood, La Molina, and, with support from Scotiabank's international group it will provide wealth management services at a few, very specific Lima branches. “But the number of people using such services, the number with high incomes, it’s not enough to rely on that,” says Mr Taboada.

“Affluent people are 80% to 90% covered by the banks. The low income segment is only 20% banked. So the opportunities do not lie with people who have two or three bank accounts or two or three credit cards in their pockets. The opportunities lie with people who do not have any bank account at all. That’s the potential of the market, where the growth lies.”

Reaching the unbanked

Currently, only about 27% of the population, or some 8 million Peruvians, have any association with a bank at all, compared with about 65% of the population in neighbouring Chile. Moreover, following a significant decline in poverty in the past five years, there are now some 5 million people who earn more than the minimum wage, live in a city but have absolutely no relationship with a bank. Meanwhile Peru has one of the biggest informal economies in Latin America, encompassing about 50% of the working population, according to Mr Velarde, and accounting for 30% of the country's GDP, bankers say.

“Inclusion is the big thing,” says Daniel Schydlowsky, the newly appointed head of SBS, and a former economics professor at Boston University and Washington’s American University. “[Along with] ensuring that if we have major macro-economic problems because of an external crisis that will probably translate into a smaller budget, that we don’t lose the capacity to keep incorporating people into the formal economy.”

BCP's Mr Bayly says: “Because [BCP has] such a large market share of the traditional banking system [35% of its credits and 36% of its deposits], for us it is very relevant to increase the size of the pie and the number of banked customers. Of the four largest banks, we are the ones that [are mostly obsessed with] increasing the size of the pie.”

The upshot is that private bankers, the government and regulators are thinking along similar lines, though from different perspectives. For Mr Humala’s government, financial inclusion is a key instrument in its social inclusion and poverty reduction plans. For private bankers, expanding financial services to more moderate and low-income markets, and managing to keep distribution costs down while doing this, is good business.

Microfinance drive

One market catering to low-income Peruvians that has changed recently is microfinance, where in the past five years credits have grown at an average rate of 23% a year, more than any other credit segment.

“The big banks were very reluctant to enter this market until recently,” says Mr Velarde. “But when they saw the opportunities, and after the small non-bank institutions and specialised microfinance banks had done [some initial] work [in the sector], they came in.”

Nowadays, obtaining finance for micro and small businesses, and obtaining a credit or a debit card to purchase goods, are the main first-entry points for Peru’s non-banked population, bankers say; and there are currently 5 million micro credit borrowers and 6 million credit card holders in the country, according to the central bank.

But the government, regulators, big banks and specialised institutions now all appear eager to increase the reach of microfinance in Peru. For instance, the Ministry of Finance is considering using guarantee funds to underwrite some microfinance lending to lower the interest rates and make microfinance more widely available.

Mibanco, Peru’s biggest micro-credit bank ($1.3bn in assets), which specialises in small and micro business lending, is also pioneering ways to link micro-lending with other services to make the lending more effective. With the support of a $36m loan recently mobilised by the Inter-American Development Bank, Mibanco is offering about 80,000 Peruvian women loans of a few hundred dollars and up to $3000 for their small businesses and, at the same time, providing them with business training so their ventures succeed.

Correspondent banking

Meanwhile another recent market where middle- and lower-income customers are targeted is correspondent banking, where big banks have been the initiators, unlike in microfinance. Foremost among them is Banco de Credito, which was the first big bank to introduce a voucher credit system, where small registers, connected electronically to a bank, are installed in corner stores and pharmacies, which Peruvians can access with a debit card and a PIN to buy goods or obtain small amounts of cash. So far BCP has installed 4000 of these correspondent banking registers and Scotiabank has started moving aggressively into this market too. But with only 8500 shops in the country currently equipped with this technology, correspondent banking still has a long way to go, regulators say.

Against this background, bankers, Ministry of Finance officials and regulators are pinning their hopes for a massive increase in the banked population on a new law that will allow simple financial transactions to be done using cellular phones and satellite phone technology, which is expected to be approved by Peru’s Congress in a few months.

Mr Schydlowsky, the country’s top financial regulator, says that with 25 million cellular phones in the country (out of a total population of 30 million) the potential for incorporating more Peruvians into the formal economy using these new technologies is “mind boggling”. He adds: “It is a way to overcome Peru’s difficult geography [desert, mountains and jungle]” and “the high cost of delivering financial services using traditional methods”.

BCP and Scotiabank, which have the technology and the resources to meet the challenge, have started negotiations on how to split the profits and costs of such ventures with the principal mobile telephone companies operating in Peru, which include Movistar belonging to Spain’s Telefonica, Claro – part of Mexico’s America Movil, and the US’s Nextel.