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AmericasJuly 2 2019

Why orange is the new black for Colombian banks

Forget staying in the black, Colombian banks are looking to the president's orange economy to help boost their fortunes. Lucien Chauvin reports from Bogotá.
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Economists increasingly talk about the green (sustainable) economy and some also envision a blue (ocean) economy, but a much different colour – orange – is the rage in Colombia and could provide a new boon for banks.

Colombian president Iván Duque sees the 'orange economy', coupled with a renewed focus on infrastructure, propelling forward South America’s fourth largest economy. In broad terms, the approach involves cultural creation that runs the gamut from architecture to tourism. Tourism, envisioned as eventually replacing oil as the country’s biggest income earner, is already rising to prominence, with 4.2 million visitors to Colombia in 2018 and 1.2 million in the first quarter of 2019.

The government, through the state-owned Bancóldex, launched a new fund in April to support the orange economy. The Duque administration hopes to have $100m in the fund by the end of 2019. Bancóldex’s initiative is loosely modelled on a similar one started by the South Korean government.

Ready to go

Colombia’s banks are closely watching and Santiago Castro, president of the Colombian Banking Association (Asobancaria), is confident they will be ready when things really start to take off. “Banks have products and services that creative industries can use to consolidate their investment projects as motors for the country’s growth,” he says.  

Banks are also keen to be involved with the country's infrastructure boom (see story, page 74), which includes several multi-billion-dollar projects that are ready to launch. “Infrastructure and construction are always key to the economy in a developing country such as Colombia. It is one of the most relevant segments in our portfolio,” says Alejandro Mejía, investor relations manager at Bancolombia, the country’s largest bank.

Banks may have products lined up, but that alone may not be enough. Colombia's banking system is solid, but cautious, continuing to rebound from a few tough years caused by scandals around infrastructure contracts, dramatic fluctuations in commodity prices, and political concerns ahead of Mr Duque’s 2018 election victory.

Banks are benefiting from an expanding economy and low inflation, but they also know that other indicators, including unemployment and fiscal pressures, could dampen confidence, and the system could be upended if a few bills in the legislature regarding fees and credit history are approved.  

“Colombia has a solid and robust financial system,” says Jorge Castaño, head of the country's financial superintendency. “As the Colombian economy continues to recuperate, companies will increasingly turn to the financial system to expand capacity and absorb new demand.”

Positive forecasts

Colombia's gross domestic product (GDP) expanded by 2.6% in 2018, up from 1.4% in 2017. The economy grew by 2.8% in the first quarter of 2019 compared with the same period in 2018, the highest first-quarter increase in five years. Investment banks and risk agencies forecast growth above 3% for full-year 2019.

The World Bank, in its Global Economic Prospects survey published in early June 2019, forecasts growth to increase by 3.5% this year – a 0.2-percentage point improvement from its original annual forecast – and by 3.7% in 2020 and 2021. The bank cites tax reform approved in late 2018 and the government’s renewed push for transportation infrastructure as helping to fuel growth in the near future.

Inflation in the country is low, coming in at 0.3% for May and 3.3% annualised through the month, and manufacturing, a key indicator, is on an upswing. The National Business Association of Colombia reported that installed capacity was at 81.8% in the first quarter of 2019, a few notches above the historic average of 76.4%. Manufacturing was up in May for the second consecutive month and new factory orders increased at the fastest pace since November 2018.

Diego Kashiwakura, vice-president and principal for Colombia’s banks at Moody’s, says: “Gradually strengthening internal demand and inflation at 3% will increase consumer confidence and stimulate demand for loans.”

Unemployment concerns

On the other side of the equation are persistently high unemployment rates, an increasing current account deficit (caused by depreciation of the peso and Colombia's trade deficit), and a tougher fiscal situation created by 2018’s tax reform.

Nationwide unemployment in April 2019 was 10.3%, up 0.8 points from the same month in 2018, according to Colombia's National Administrative Department of Statistics (DANE). The current account deficit was 4.6% of GDP in the first quarter, compared with 3.5% a year earlier, according to Banco de la República (the country's central bank). In monetary terms, the 2019 amount was $3.6bn, compared with $2.8bn in 2018. DANE reported that the trade deficit was $2.4bn in the first quarter of 2019, compared with $1.2bn in the same period of 2018.

Asobancaria’s Mr Castro says persistently high unemployment levels could affect the banking sector. “While we anticipate a good year for loans, the level of uncertainty [from unemployment] could lead some consumers to postpone purchases and lower the demand for consumer loans,” he says.

This mixed news has led to conflicting moves by two rating agencies, Moody’s and Fitch, which released contradictory reports on May 23. Moody’s revised its outlook for the sovereign to 'stable' from 'negative', citing the country’s recovering economy, while Fitch lowered its outlook to 'negative' from 'stable', pointing to increasing debt and fiscal constraints.

The outlooks for the country’s banks rated by the two agencies also changed to reflect the sovereign position. “The 'stable' outlook reflects Moody’s view that downside and upside risks are broadly balanced now that medium-term growth prospects and commitment to fiscal consolidation will prevent an erosion in the country’s fiscal strength,” the agency said in its report.

Banking mixed bag

Of the five Colombian banks rated by Moody’s, three have 'stable' outlooks, while two have 'negative' outlooks. Moody’s Mr Kashiwakura says stronger economic growth would create better conditions for banks, adding that banks are expected to stabilise their asset quality and improve capital buffers.

“The economy will recover in 2019 to 2021 with growth ranging from 3% to 3.5%, supported by an increase in private investment and consumption, which will compensate for lower public spending as the government pursues fiscal consolidation,” he says.

Fitch, on the other hand, took at broader look at the economy, saying: “Ratings are constrained by high commodity dependence, limited fiscal flexibility and structural weaknesses in terms of low GDP per capita and weaker governance indicators relative to peers.”

Andrés Márquez, senior director for Latin American financial institutions at Fitch, says that while the agency lowered the outlook for the banks it rates to reflect the sovereign’s position, Colombia’s banks are on a solid footing.

“Colombian banks are in a good position. They are coming out of a complicated period when the macroeconomic picture in the country was not very good in 2016 and 2017. The system is reaching a point of inflection in such a way that it should be start expanding at a faster pace,” he adds.

Latam star

Colombia’s financial system ranks second only to Chile in South America in the Global Competitiveness Index 2018 prepared by the World Economic Forum. It ranks 53rd out of 140 countries internationally, while Chile is 20th. In the broader Latin America/Caribbean region, Colombia scores 63.8 on the index’s zero to 100 scale. The regional average is 59.5 points.

The top three banks in Colombia control 52% of the market, a percentage lower than most countries in the region, according to Mr Castaño. The level in neighbouring Peru is 72%, in Brazil 70% and in Uruguay 69%. Total assets in the system are equivalent to nearly 70% of the country’s $336bn GDP.

Bancolombia is by far the largest domestic bank, with $49.1bn in domestic assets as of April 2019, according to the financial superintendency. Banco de Bogotá is next with $27.3bn, followed by Davivienda with $26.6bn.

“Although the top three banks [make up] half of the market, if the market is broken down by products and the size of institutions, a large number of institutions are in the consumer loan segment,” says Mr Castaño.  

Potential trouble

While banks expect growth going forward, a few things that could slow progress are being carefully watched, including the possibility of legislative changes, and political and economic turbulence in Central America, where Colombian banks have important exposure.

The sector is already critical of the corporate income tax surcharge for financial entities that was approved in December 2018. The surcharge is 4% for 2019, falling to 3% for 2020 and 2021. The move basically means that financial institutions will be paying the same taxes as they were prior to the reform, while all other corporations see their tax burden drop to 33% in 2019, 32% in 2020 and 31% in 2021.

Coming on top of the surcharge could be legislation eliminating fees for credit and debit cards. The legislation has been approved by the lower chamber of Congress and has been making its way through the Senate. A vote by a Senate committee was cancelled in mid-June, increasing the likelihood that the bill will not be taken up until the next legislative session gets under way in the second half of 2019.

Fitch’s Mr Márquez says approval of the legislation, which the Duque administration does not back, would have a ripple effect on the sector. “The proposal to eliminate the fees charged by banks for credit and debit cards would have a major impact. Some estimates put the loss at approximately $1bn,” he says.

Credit history fears

Another potential legislative change, which is more subtle but as concerning for the banks, is a move to limit the scope of credit bureaus. If the bill were to pass, credit bureaus would only be able to present limited credit histories requested by financial institutions to approve operations. In general terms, if someone were late in repaying a loan 18 months ago, but was current today, the prior late payments would be expunged.

Opponents of the proposed legislation scoff at the claim that limiting the scope of credit checks would boost financial inclusion, helping incorporate the 6.3 million adults in the country that do not use the financial system. They argue that the move might actually be harmful, with banks less willing to bet on new clients and increasing rates to protect against potential losses. Colombia has a high level of financial inclusion, with 81.4% of adults, or 28 million people, using at least one financial product, according to Asobancaria.

A final issue is international exposure. Colombian banks rank high in the region for their level of internationalisation, representing more than 50% of the market in Costa Rica and El Salvador, and holding important positions in other Central American markets. Approximately 30% of assets in the Colombian banking system are in Central America. Rising political and economic pressures in Central America, however, pose a risk.

“While international operations increase the value of a franchise and potential for earnings, as well as diversify banks’ geographic and commercial footprints, they also increase exposure to operating environments that are more volatile,” says Mr Kashiwakura.

This is currently the case in Costa Rica, where the government has enacted sweeping fiscal reform, and in Nicaragua, where a year of international political fighting has battered the economy.

Growth options

Concerns aside, Colombia's banking system has a number of areas that are promising for growth, including the expansion of the core business of attracting deposits and offering corporate and consumer loans, as well as mortgages. 

Corporate loans continue to be the most relevant segment, representing 53% of all loans in the system at the end of the first quarter of 2019. Corporate loans have shrunk slightly, while consumer loans and mortgages have increased in the past three years. “In the corporate segment, we expect the economy to grow vigorously in the second half of 2019, which should lead companies to use lines of credit we have designed for each kind of business,” says Bancolombia’s Mr Mejía.

“Loans for home purchases have been the most dynamic so far in 2019,” says Mr Castaño, with an increase of 8.57% through April. Corporate loans were up 0.61% in the first four months of the year, while consumer loans were up 7.32%.

Mr Castaño says the financial system “has the resources to address any risk that might materialise with credit portfolios”.

Colombia, like many other South American countries, does not have deep capital markets, leaving banks to pick up the slack. “Unlike the US and Europe, Latin America did not have a financial crisis and banks have been solid for years. Banks are in a position to offer loans under favourable terms, making them a source of financing for companies,” says Juan Pablo Córdoba, head of the Colombian stock exchange.

Consumer loans climb

Consumer loans have been increasing in Colombia, reaching 30% of loans in the system as of the end of March 2019, and Mr Kashiwakura says the slow upward trend should continue for the foreseeable future.

“Bancolombia sees the consumer loans as the fastest growing segment. We have focused our efforts in the past few years on increasing our participation in the consumer portfolio,” says Mr Mejía. He believes consumer loans should be a little stronger than they were at the start of the year, likely expanding by 8% for the whole of 2019. “Our expectation is that banks will continue to be prudent with respect to consumer loans,” he adds.

Asobancaria is bullish, meanwhile. It highlights increasing opportunities for banks to help finance infrastructure projects, particularly highway construction, known as the 4G programme; get further involved with start-ups, who form part of the orange economy that the government sees as Colombia’s future; as well as boost their own tech footprint.

Local banks accounted for 36% of the $7.4bn in funding for 15 highway projects with financial closure between 2016 and the first quarter of 2019. This peaked at 40% in 2017, but banks still account for the largest single source of financing for such projects in the country, according to FDN, the state development bank. “Colombian banks play a fundamental role in financing infrastructure projects,” says Asobancaria’s Mr Castro.

Mr Kashiwakura says that continued progress on the 4G programme, besides public investment in other public works as the October 2019 regional elections approach, will act as a catalyst for economic expansion and a continued source of growth for the country’s banks.

Mr Mejía says his bank is ready. “Bancolombia has the expertise and capacity to finance big tickets. We have the conditions necessary to finance this segment over the long term,” he says.

An orange boom

Banks are also looking to cash in the country’s creativity and innovation – the 'orange economy' – with start-up labs multiplying and the government of Bogotá, Colombia's capital, moving ahead to create the Bronx Creative District. The $60m project aims to transform a former violence-riddled inner-city zone into a magnet for start-ups and other creative industries, from art to music.

It helps that Colombia is the birthplace of Rappi, an on-demand delivery service that has spread throughout Latin America. Rappi raised $1bn earlier in 2019 from Japan’s SoftBank, becoming the region’s second ‘unicorn’ (a start-up valued at more than $1bn). 

A number of other Colombian start-ups, including Platzi, a platform for online tech learning, and Hogaru, a house-cleaning service, hope to follow. Platzi, with about 1 million students in 20 countries, recently secured financing from Silicon Valley’s Foundation Capital. It was also the first Latin American start-up backed by the California-based accelerator Y Combinator.

“There is a boom, thanks to Rappi. There are several start-ups that are doing well and have private equity investment. Everyone is looking for what might be the next unicorn,” says Paula Osorio, vice-president of ColCapital, the association of private equity funds.

Besides looking to be involved in start-ups, Colombia's banks are making major leaps with technology to improve services, attract new customers and strengthen the bottom line. Helping facilitate this is legislation approved earlier in 2019 that permits banks and others in the financial sector to invest in fintechs, providing new incentives for collaboration.

“Innovation has become one of the principal goals of Colombian banks. A priority for the sector is adopting digital transformations that contribute to increasing competitiveness while maintaining an ecosystem that provides confidence and security to customers,” says Mr Castro.

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