Is further regulation needed to protect the financial industry from external problems?
CARLOS GONZÁLEZ-TABOADA: The financial system was in a very complex situation after 2000. Capitalisation levels were low and portfolio/asset quality was a point of concern. Therefore, private entities and regulators spent a decade taking initiatives to support the quality, liquidity and solidity of the system. Today, thanks to strong regulation, we have improved the capital base, procycle provisions and liquidity reserves. I do not think Peru needs additional regulation to be protected against a global financial crisis. The system is still denominated in US dollars, at least to 50%, which is an issue. However, the nuevo sol is taking more of a hold and the legal reserve and the other regulations are very strong, indicating that local banks will be well equipped to deal with any crisis. The reserves for deposits in dollars are the highest in Latin America.
LUIS FELIPE CASTELLANOS: I do not think Peru needs further regulation. I think our regulator has done an excellent job. Overall, capitalisation is 13.5%, which means we are already Basel III compliant in this respect. We have regulations to limit the ability of banks to invest in foreign toxic assets. With years of expected growth, it is important to have a solid, well-capitalised financial system.
JOSE ANTONIO BLANCO: Our regulator took several measures a couple of years ago to include some pro-cyclical reserves requirements, which have allowed the banks to form incremental provisions. At this point, I do not think further reserves are required. We have a very liquid banking system and, on the whole, our loss provisions and delinquency ratios are very low, especially compared to other places around the world.
EDUARDO TORRES-LLOSA: Our regulatory framework is one of the most advanced in the region and follows the recommendations set by multilateral institutions. We are also gradually moving towards the Basel III guidelines. Furthermore, since July 2011 the Peruvian banking system has to fulfil additional capital requirements. The system is, I think, both well capitalised and very liquid.
What are the strengths and weaknesses of the central bank’s tight control of currency inflows?
TORRES-LLOSA: A strong capital inflow might distort some key macroeconomic variables (like the exchange rate), affect the competitiveness of tradable goods and, under some circumstances, induce asset price bubbles. The probability of these risks is higher in small open economies, like the Peruvian one, that eventually cannot absorb huge amounts of capital inflows. Therefore, in Peru the central bank has usually reacted to minimise any potential negative impact of these inflows on the economy using its monetary instruments – basically reserve requirements for foreign currency deposits and loans from abroad. However, there must be a balance between managing capital inflows and the development of the financial intermediation. The latter is an important determinant of long-run economic growth. A tight control on capital inflows may restrict the access of local economic agents to external savings as an alternative funding source. GONZÁLEZ-TABOADA: The central bank’s intention, in my opinion, has been to cap market volatility and also bring the impact of these inflows under control, which could have otherwise led to inflation and FX volatility.
CASTELLANOS: The pros are that it adds predictability and removes volatility, so the local players can adapt to what is coming and have a predictable base for operations. So far, the central bank has been prudent in its intervention so as not to distort overall market trends.
BLANCO: The central bank’s control of monetary policy allows local banks to enjoy some predictability of how the central bank will react to possible rises in inflation or a change in exchange rates. This gives banks a lot of comfort to focus on their core business – serving customers. In 2006/07, there were huge inflows of money. People were betting on the local currency to appreciate, making a profit on the exchange rate and taking dollars back home. The bank saw this as an attack on the exchange rate and increased the reserve requirements to 120%, bringing the rate back under control.
To what extent will we see bank consolidation in Peru and how will the sector will continue to grow?
BLANCO: The financial system is still very small compared to the official GDP, although the real GDP is much higher if you consider the informal sector. That represents a very attractive opportunity for banks to keep on growing. Instead of seeing consolidation, we will see new banks coming into Peru, which is good news. Having more banks in the system will provide a wider variety of competitive services to the growing customer base, which is becoming more demanding.
TORRES-LLOSA: For the long run, the outlook for the industry is promising. In recent years, there has been the emergence of a middle class. Margins in the financial system are high and Peru has become a place for investment, which was not the case 10 years ago. The market will see more competition, but this will not happen for several years due to the turmoil in financial markets, as banks are more concerned with evaluating their current capital positions. Local banks, therefore, have gained some time to prepare accordingly, but we are also certain that other banks will enter the market. First, it will be regional banks from Colombia and Brazil, followed by US, European and Asian banks. GONZÁLEZ-TABOADA: The strong growth of the financial system over the past five years has created room for more entities to enter the market. We will see new banks coming into the sector, rather than consolidation. It could be, however, that eventual consolidation on a global level might have an impact on the local banking system. We will see two or three medium-sized entities entering the market this year and other regional banks coming in within the next two to three years.
CASTELLANOS: I do not see much room for mergers of existing institutions. The top four banks have more than 80% of the market share. Once the international environment becomes quieter and more predictable, banks that have solved their issues in their home markets will be interested in coming to Peru given the high profitability and growth the country is experiencing. New entrants will probably focus on providing a specific service within the system itself, such as wholesale banking, the credit card business or dedicated services to small and medium-sized enterprises (SMEs).
Will construction finance and mortgages for low-cost housing provide profit-making opportunities for the country’s lenders?
CASTELLANOS: Banks are currently heavily looking into this segment. It is the future. About 2m houses are needed to cope with current demand and the supply is around 100,000 units per year. Many players now want to enter the government housing programmes segment, such as Techo Propio and Mivivienda. Another example is the mortgage segment. We have 30m inhabitants and only around 160,000 mortgages, which is a lot lower than neighbouring countries. If we look at Chile, for example, it has 16m people and 1.2m mortgages.
BLANCO: It will not be easy to close the huge housing gap. The banking system plays an important role in aiding the development of housing units. There is tremendous growth potential. However, financing these projects requires government help, especially in low-cost housing segments like Techo Propio and Mivivienda.
TORRES-LLOSA: Housing loans amount to only about 4% of GDP, which is fairly low compared to other Latin American countries, where figures are at around 10%. This implies that there is a huge upside. Social housing is booming and we foresee this trend will continue. GONZÁLEZ-TABOADA: The construction sector has grown by 6-10% over the last five years, driven by private sector provision of homes and offices. The mortgage sector for banks has been growing by 25-30% over the past five years, making it one of the most diversified and biggest activities of local banks. Initially, construction was more focused on housing for the upper-income segment, but priority is now being given to middle-income and emerging households. In future years, more attention will be paid to emerging and lower income homes. The current mortgage market for all houses amounts to some 160,000 mortgages, so the opportunities for banks are very large. This is also true for new commercial and office buildings. In 2010 and 2011, we saw at least 10-12 new malls begin operations, so retail activity is rising.
How, in your opinion, will bankarisation rates improve, particularly in the provinces?
GONZÁLEZ-TABOADA: It is important to give access to banking services to people that were part of the informal economy or did not have access before. To achieve this, we need alternative channels. It is not possible to reach the entire country with traditional banking branches. We need specialised models, since people who do not use financial services will do so if there is a something that suits them. Banks must be proactive in acquiring new customers through a well-established ATM network, mobile banking or with point-of-sale facilities in alliance with other commercial entities. Banks have to make themselves visible to the people. We estimate there will be twice as many growth opportunities in the provinces compared to Lima.
CASTELLANOS: Indeed, there is a clear focus within the sector on the provinces. Bankarisation goes in line with expanding the branch network, which is still lagging behind. In Peru, there are five branches per 100,000 inhabitants, whereas in Argentina you have 10 and in Chile as many as 13. It is indeed true that there are also huge opportunities with regards to mobile banking. There is, on average, one phone per person in Peru. Therefore bankarisation is going to improve through alternative delivery channels. Expanding products will also help increase the penetration of bank services. One example is credit and prepaid cards targeted towards emerging consumers in the provinces that did not have access to such services before. Banks understand the provinces will move the economy forward in the future.
BLANCO: If you had come to Peru five years ago, you would not have seen any correspondent agencies, such as pharmacies where you are able to do basic transactions. Right now, we have thousands of them and that basic service is letting the population know there is a bank nearby. It will still take time to improve bankarisation rates further, but we have improved rates from 20% a couple of years ago to 30% at present.
We still lag behind countries like Colombia, where the rate is in the 40-50% range, or Chile, with a figure as high as 80%. It is important not to see the glass half empty. It is half full. The low bankarisation rate represents a clear opportunity, not a problem. New products such as mobile wallets will also be a huge door opener for segments that do not now have access to banks.
TORRES-LLOSA: Increased bankarisation is happening and this process will continue. We have seen more than 24% growth in our client base within the past 12 months and, indeed, the entire financial system is experiencing high growth rates. The microfinance services sector is also soaring as well.
What happens in a country when you have financial and macroeconomic stability over 20 years? Well, bankarisation will increase significantly, which is what is happening. The same can be said for growth in mortgage loans. What will now happen is the further development of capital markets. It took more time than we expected, but it is about to happen. It is also very interesting to note that the Peruvian financial consumer is becoming much more educated, which is a good thing.
How are banks improving credit provision to SMEs and what kind of challenges does this present?
BLANCO: SMEs right now have fewer financing alternatives than large corporations, which also have access to capital markets. While small enterprises are a specific target market of microfinance entities, medium-sized firms can access a wider range of commercial banks due to their credit and product needs. It is important to mention that a large portion of these SMEs are also suppliers to larger corporations and thus can be indirectly served by almost all banks by the discount of their receivables, which happens through electronic solutions offered to these large corporations. In this way, even small companies can benefit from financing by large banks by using the credit facilities of their large corporation clients. In the near future we should also see important changes in capital markets regulations in order to allow access to medium-sized companies. GONZÁLEZ-TABOADA: Peru has considerable microcredit know-how, much greater than most of the rest of Latin America. Key to expanding credit to this sector is technological support, artificial intelligence models and a flexible approach to attracting customers. The challenge for banks is how to approach customers in an economical and viable way, since this target group is not always interested in using bank services and products. Another issue is evaluating the linked risk, as many potential customers do not operate in a formal manner. Everything related to giving loans is based on experience. The secret is how you use this experience.
CASTELLANOS: There will be new products offered, specifically tailored towards the needs of the growing SME segment. Before it was only working capital. Now they are being treated as larger commercial firms and enterprises, so these companies are seeing more variety in the kinds of products available Today, these kinds of companies have access to foreign commerce products and, for example, leasing services, which did not exist before. Banks are trying to understand this new type of customer better, collecting more business intelligence and working on segmentation to understand their different needs. Those efforts will results in more targeted financial products, facilitating the growth of SMEs.
What is your forecast for the growth of the banking sector, and how will it compare to GDP growth? How will this expansion be funded?
TORRES-LLOSA: Basically all sectors will grow: corporate, middle-income companies, small enterprises, consumption mortgages and loans. The system’s actual growth will depend on national GDP, which we project to be at an average of 5% in the long run. Loans will grow between 15-18% annually, so bankarisation will be pretty fast. However, we need to work on ways to foster opportunities. There are several measures the government could do to speed up the bankarisation process, such as the improvement of central information systems and enhancing property rights.
The system as a whole is facing a major challenge. Loans are growing faster than deposits. Two or three years ago, our system had a surplus of deposits, so financing our growth was pretty straightforward because it was funded by client resources. This will not be the case in the coming years. Banks will have to diversify their sources of funds and rely much more on major sources of financing,. However, the banking industry looks optimistic. We learned from the crisis in the 1990s and are no longer dependent on short-term loans from banks. Now the system only has $1.7bn in short-term loans from US and European banks. This is very low. GONZÁLEZ-TABOADA: We need to link the banking sector with the increase in GDP. If the country grows by the projected 5-7%, we will grow around 12-18% per year for the next couple of years. With the correct amount of stability, and remembering that investors must be protected, the country could grow by over 5%. This would reflect well on the financial system, with more institutions beginning operations. We are confident Peru will be a leader within the next three to five years.
CASTELLANOS: There is ample room for growth. The banking sector will grow between two and three times the rate of the GDP increase, so it will be up to 15-20% in the coming years. Despite the strong growth Peru has already experienced, I believe this is just the start.
BLANCO: With the economic, fiscal and monetary stability Peru has, along with the low bankarisation level compared to the GDP, the outlook for banking industry is positive. We expect the sector to grow three times faster than GDP, and we, therefore, estimate growth to be at 15-20% in the next five years. We believe the bankarisation level will increase from 30% to around 50%.
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