Reaching out: A growing middle class presents new opportunities

Significant growth has been achieved in the banking sector over the last several years as more and more low- and middle-income Peruvians gained access to an increasing number of financial products specifically tailored to suit their needs and incomes. According to statistics published by the Superintendency of Banking, Insurance and Private Pension Funds ( Superintendencia de Banca Seguros y AFP, SBS), bank lending to the private sector jumped 16.6% year-on-year (y-o-y) in January 2012. Much of this increase was fuelled by growth in consumer and home loans, up 20.2% and 27.2% respectively.

In terms of profits, the banking industry is faring extremely well for the moment, with all of the big banks reporting return on equity of between 20% and 30%. The country’s largest bank in terms of assets, Banco de Crédito del Perú (BCP) recently announced a 15% increase in fourth-quarter 2011 earnings, y-o-y.

While low banking penetration levels indicate that there is still much work to be done and therefore significant opportunity to grow, the sector’s strong profitability has caught the attention of numerous foreign banks whose entrance is expected to create a more competitive environment before the end of 2012.

NEW CUSTOMERS: Hugo Perea, the chief economist at BBVA Continental, credited the industry’s expansion to two main factors. “First, it is the growth of the economy. In spite of a turbulent global economy, we have been experiencing sustained growth for 13 years now. This leads me to my second point, which is job creation and business growth. Most importantly, economic growth has created more jobs in the formal sector, and employees in the formal economic sector are potential new customers for us,” he told OBG.

Ramón Larrea Dávila, the CEO of Financiera Universal, agreed. “Sustained economic growth over the past 10 years means that every year there are many potential new clients for the financial sector,” he said.

As employment has increased so too has income, with GDP per capita rising substantially from $3312 in 2006 to $5401 in 2010, according to World Bank data. A recent report by BBVA Research, showed workers’ income in metropolitan Lima increased by 5.4% in 2011. With this growth, the banking sector has benefitted from rising demand for consumer goods and homes. “The most important thing happening in Peru right now is the formation of a middle class. This is allowing us to increase our level of market penetration throughout the country,” Guillermo Arbe, the chief economist at Scotiabank, told OBG.

HEALTHY GROWTH: With lending rates increasing at such a rapid pace, asset quality becomes a natural concern. While some speculate over whether or not the banking sector’s growth is healthy, Perea would advise those in doubt to consider the country’s comparatively shallow financial system. “Even with this rapid increase in loans, Peru’s loans-to-GDP ratio hovers around 30% at the moment, which is about average for Latin America and far behind other countries with lower GDP per capita,” he said.

Indeed, the last available statistics from the World Bank indicate that Peru’s loan-to-GDP ratio was at 24.3% in 2010, significantly behind that of Nicaragua (32.6%), El Salvador (41%) and Bolivia (40.3%). That said, non-performing loan (NPL) ratios are further indicators of sound growth. According to the Peruvian Association of Banks, the average NPL ratio for the system overall was 1.47% in December 2011.

NPL ratios are naturally higher for banks focused on providing consumer and small business loans to previously unbanked customers. Banco Azteca and Ripley, for example, experienced the highest ratios of 6.89% and 5.13%, respectively.

ASSESSING RISK: Improvements in credit risk assessment at Peru’s big banks as well as many of the more established microfinance institutions (MFIs) have led to a steady decline in NPL ratios over the last year and a half. René Jaime Fárach, the CEO of CrediScotia, told OBG, “Since the bank was founded in 2009, our ability to assess credit risks has improved significantly. The risk models that we have developed allow us to serve thousands of customers practically by just inputting their ID card information in our technology platform.”

SBS plays an integral role in making this sort of rapid risk assessment possible. For customers with a history of prior usage of banking products, SBS is able to provide potential lenders with a thorough credit history. However, SBS is not yet able to provide a credit profile on previously unbanked customers, who imply a natural credit risk.

AVOIDING OVER-INDEBTEDNESS: Given a substantial increase in consumer lending (up 20.2% as of January 2012 over the previous year) some leaders in the sector have expressed concern over the potential over-indebtedness of clients. Large increases in the amount of financial products available to segments of the population previously excluded from the banking sector are the primary cause behind this concern.

According to José Beltrán, the planning manager at CrediScotia, “Some banking customers have a debt-to-income ratio of 30-40%. I think once you get above 30% this begins to affect your day-to-day spending and is a cause for concern.”

Alonso Segura, the head of strategy and chief economist at BCP, said, “You might have some overstretched borrowers in some segments of the population, but this is not an overall or systemic issue.” To prevent it from becoming one, SBS is continuously adapting its policies to ensure that MFIs have sufficient capital reserves to cover all eventualities. Also, many of the MFIs or banks focused on consumer lending have created internal policies of denying loans to individuals or microbusinesses with more than three creditors.

“SBS is putting in place a debt restructuring programme and a strategy to maintain liquidity levels in the face of global financial fears,” Ana María Zegarra Leyva, the CEO of Financiera Edyficar, told OBG.

EUROPEAN CRISIS & OTHER CHALLENGES: The European economic crisis remains a potential challenge to the continued growth of the banking system, though leaders from the sector appear increasingly more confident in banks’ ability to avoid the fallout of any significant downturn in Europe. According to Segura, “We are less concerned than before as it seems Europe will experience a more moderate recession as opposed to a sharp downturn.”

In the light of events in Europe, SBS has continuously worked to assure investors as to the strength and preparedness of the banking sector, claiming that banks’ substantial profit margins over recent years have allowed them to amass significant capital buffers that are capable of supporting the sector through both domestic and internal shocks.

As proof of the banking system’s strength, Arbe recalled events during the 2008-09 global economic crisis. While Peru’s GDP growth dropped significantly during that time from 9.8% in 2008 to 0.8% in 2009, there were no major bankruptcies among banks or large companies. In fact, the sector had positive returns on several key indicators: “Loan growth continued,” said Arbe. “The banking system even increased its earnings that year.”

China appears to be a bigger long-term concern for Peruvian banks. As the country’s largest trading partner, China is an avid consumer of Peruvian commodities such as copper and iron. Any significant internal slowdown in China could present serious consequences for the Peruvian economy as a whole.

According to Arbe, “The US or Europe could go into recession without causing a crisis here. But if China’s growth rate were to slow to approximately under 5%, this would become a source of concern for us.”

OPPORTUNITY AHEAD: Barring any major economic downturns in Europe or China, continuous growth is expected in the sector through the near to mid-term. This will be buoyed by an expansion in infrastructure, as all major banks and MFIs work to extend their networks by installing more ATMs, training third-party banking agents and opening new branches. Efforts such as these should lead to increased market penetration, which Arbe predicted would grow from 30% in 2011 to around 45% within the next five years.

Mario Alberto, senior analyst at Scotiabank, told OBG that 2000-20 would be an important time for the sector due to demographic changes. The median age in Peru is currently 26. As these young adults enter into formal employment with growing pay rates, they will become valuable potential customers.

While BBVA researchers anticipate a slight slowdown in lending growth rates overall in 2012, mortgage and consumer lending rates should continue to rise steadily by more than 20% as banks remain focused on reaching out to Peru’s expanding middle class.

As more competitors enter the market and economic growth slows moderately in the coming years, bank earnings are expected to stabilise. “We expect earnings to slow down a bit in the future. Right now they are high and this attracts the attention of competition. Over time our margins will drop to more ‘normal’ levels but we will continue to make gains because there is still a lot of opportunity here,” said Perea.