Ask anyone in Uruguay about the country’s banking system and they will tell you about “the crisis”.
The crisis is not the international financial collapse in 2008 nor, more recently, the Covid-19 pandemic that caused a near 6% decline in gross domestic product (GDP). It was an event two decades ago when, in 2002, Uruguay was pummelled by a crisis that began the previous year in neighbouring Argentina, spreading and wreaking havoc.
Uruguay’s banks, which were highly exposed to deposits from Argentines, lost more than 20% of their deposits in the first few months of 2002 and the government was forced to intervene in private banks to avoid a systemic collapse.
When the dust settled, the economy had contracted by 7.7%, unemployment spiked to 20% and poverty jumped to 33%, according to the World Bank. Uruguay had 23 banks before the crisis; it has 11 today.
“Uruguayans are still traumatised by the crisis of 2002, which caused the worst economic and social crisis since its return to democracy in 1985,” says Nicolás Saldías, an analyst for Latin America and the Caribbean at the Economist Intelligence Unit.
The crisis has since made Uruguay’s banking system strong and prosperous. Banks are liquid and solid, with one of the best deposit-to-GDP ratios and lowest non-performing loan levels in South America. In 2002, 35% of deposits were held by non-residents, with the number coming down to 10% in 2020.
The crisis and ensuing reforms also gave Uruguay, with its population of 3.5 million people, the unique standing in the region of having no homegrown private banks. It has two state-run banks and nine private banks, all of which are units of large international banks.
Uruguay’s banking system is dominated by five banks that have more than 93% of the market. State-run Banco de la República Oriental del Uruguay (BROU) is far and away the largest, with 41% market share. Following it are Santander with 18.3%, Itaú with 14.6%, BBVA with 10.7% and Scotiabank with 8.9%. The state-owned Banco Hipotecario is a mortgage lender, with five other private banks filling out the market.
“We have a post-2002 crisis system that has strong regulations and is much improved. It is a system with private international banks that do not take risks,” says Javier de Haedo, head of the Economic Observatory at the Catholic University of Uruguay.
In its Article IV review published in January 2022, the International Monetary Fund (IMF) highlighted the financial sector’s resilience. “Stress tests of the banking system showed that it would withstand a severe recession scenario. Going forward, the authorities are working on deepening capital markets based on international best practices,” it stated.
Room to grow
The financial system’s solvency and the country’s position today, with macroeconomic numbers improving and international investment on the rise, point to growth in the banking sector.
“I think Uruguay has significant opportunities for growing the banking sector. There is room in consumer lending and a great deal of space for corporate lending. As a country, Uruguay offers important conditions for investment,” says Salvador Ferrer, president of BROU.
The ratio of deposits to GDP is close to 60%, which is strong by regional standards. Mr de Haedo says the system is extremely liquid. “The conservative approach has served them well. The banks are liquid, solvent and safe,” he adds.
Investors are looking at stability and transparency, which are qualities that have always identified Uruguay
Capitalisation is two-times the required levels. Central bank governor Diego Labat says the system is healthy, joking that Uruguay’s “problem” is the envy of other countries. “The concern here is that maybe our system is too liquid,” he says.
The flip side of the equation is with loans, where the system — and Uruguayans in general — are cautious. Banks generally avoid risks and Uruguayans prefer to avoid debt, according to Mr de Haedo.
This has led to a loan-to-GDP ratio of around 25%, which is well below international standard. It is another legacy of the 2002 crisis.
“The low loan ratio is a holdover from 2002. Uruguayan businesses are very cautious when it comes to debt,” says Mr Ferrer. “The loan-to-GDP ratio shows that there is clear room for growth in all sectors and our bank is leading the way on this.”
Economic strength
Mr Ferrer says the country’s rebound from the pandemic and a strong commodity cycle, together with Uruguay’s image in the region, were creating the conditions for sustained economic growth that would see the banking sector register a solid performance in the coming years.
Uruguay’s economy expanded by almost 4% last year and the government is forecasting similar growth in 2022. The economy is benefiting from investment, including the $2.7bn investment by Finland’s UPM in a new pulp plant. Another $350m is going to a pulp export facility at the Montevideo Port. The plant will be the single largest investment in Uruguay’s history when it starts production in 2023.
Foreign direct investment (FDI) in Uruguay in 2020 was $2.6bn, up 43% from the previous year in spite of the pandemic. Last year’s FDI numbers are not yet available.
Exports in 2021 reached a national record of $11.5bn, and were up by 43% compared to the previous year and by 26% from pre-pandemic 2019. China solidified its position as Uruguay’s top export market, representing 28%. Neighbouring Brazil was next with 16% and the EU at 14%. All other export markets were in single digits.
Beef remains the country’s top export, bringing in $2.4bn last year, but pulp continues to move up. It is the second-largest export, at $1.6bn last year.
While slightly more moderate growth is expected in 2022, the country got off to a good start in January, with exports up 31% from a year ago, according to Uruguay XXI, the government’s promotion agency. Exports to China were up by an eye-popping 111% in January.
President Luis Lacalle’s government is also optimistic about employment, which has recovered from the pandemic. Unemployment was 7% in December, down from 7.4% the previous month, and at a four-year low.
Mr Ferrer says that future growth in the banking system is not only a result of the economic numbers, but other indicators including institutional stability, legal security and transparency. Uruguay ranked 18th out of 180 nations in Transparency International’s 2021 Corruption Perception Index. Next in South America was Chile, in 27th. It ranked first in the region and 25th out of 139 countries worldwide in the 2021 Rule of Law Index by the World Justice Project.
“I think investors are looking at stability and transparency, which are qualities that have always identified Uruguay. They are making Uruguay a new port of entry for investment in South America,” says Mr Ferrer.
He also stresses Uruguay’s energy market — and overall environmental, social and governance positioning — as an added attraction. Uruguay produced 97% of its energy from renewable sources in 2020 and it is ranked first among emerging economies in the Energy Transition Index.
Time to de-dollarise?
While the picture is positive, a few big issues trouble bankers and analysts. First is inflation, which was at 7.9% in 2021. Although this is down from the previous year, when it topped 9%, it is still outside the target band.
The Central Bank of Uruguay wants to bring it down to 3–6%, but the numbers from January show that this will be tough. Inflation in January was nearly 1.8%, pushing the 12-month number back up to 8.2%.
The other issue is dollarisation. Uruguay’s economy is highly dollarised — much more so than other emerging economies. In an early February report, Moody’s warned that high dollarisation poses risks to banks and broader stability. Uruguay tops the ratings agency’s list with the highest dollarisation of emerging economies. The country has deposit dollarisation at 74% at the end of 2020, according to the report.
The IMF also highlighted this problem in its review. “Dollarisation also remains an obstacle to investment and growth. Private credit remains low, partly because financial intermediation remains highly dollarised and firms tend to be under-leveraged and under-invest because of the lack of peso credit,” it stated.
Mr de Haedo, however, argues that dollarisation should not be considered a central issue. “The campaign to de-dollarise is a little like Quixote, with the central bank fighting against windmills. Uruguayans do not have a problem with dollarisation. It is one of our idiosyncrasies,” he says.
Instead of focusing on dollarisation, Mr de Haedo thinks that the attention should be on creating new trade openness, including free-trade agreements to boost exports and add jobs. He says that Uruguay — despite the stumbling block created by its common market with Argentina, Brazil and Paraguay (Mercosur) — needs to find way to negotiate agreements, starting with China. “We don’t want to break with Mercosur, but it does not work the way it should,” he says.
Mr Ferrer sees a combination of approaches as the solution. He says the state needs to keep inflation in check, which would help with de-dollarisation, but it also has to work on greater trade in goods and services.
“The economy has recovered faster than expected. We are in a virtuous circle, with expectations that commodity prices will remain strong. I perceive a lot of interest and we are ready for investors,” he says.
