Ready to grow: Sector stakeholders work together to increase penetration

In 2008 Peru, like most other economies at that time, suffered an abrupt slowdown. GDP growth dropped from 9.8% in 2008 to 0.8% in 2009, according to World Bank data. The banking sector, which had been on the rise since 2003, was also affected as credit growth sputtered. However, as banks in the US and Europe faced buyouts and nationalisation, Peru’s banking sector held firm. With a sound regulatory body, hefty capital reserves and very limited exposure to complex financial instruments, not a single Peruvian bank was forced to close. In fact, retail lending even grew in 2009.

The sector has continued its expansion ever since, led by the conscious efforts of banks and regulators to increase market penetration among the country’s growing middle class. As more foreign banks are drawn to the market in the coming years, consumers are likely to benefit from an increasingly competitive banking system intent on expanding retail services.

LAY OF THE LAND: The country has a total of 15 banks and 59 financial institutions, including 34 microfinance institutions (MFIs). Despite this diverse offering, according to the Peruvian Association of Banks (Asociación de Bancos del Perú, ASBANC) more than 80% of total bank assets are held by only four banks: Banco de Cré dito del Perú (BCP) (35% of total assets), BBVA Continental (22%), Scotiabank (15%) and Interbank (10%). Five of the 15 banks are Peruvian-owned and operated, including BCP, Interbank and Mibanco, the largest microfinance bank in the country measured by asset value. Among the foreign banks, the Spanish BBVA Continental and Canadian-owned Scotiabank are the largest, offering a full range of banking services. Chile’s Banco Falabella and Banco Ripley are both very active in the market for consumer loans and credit cards.

Citibank, HSBC, Santander and Deutsche Bank all maintain small operations based in Lima. Of these four, HSBC, which offers retail and wholesale banking as well as asset management and insurance, is pushing forward with the most ambitious expansion plans. The bank recently announced an investment of $30m in its Peruvian retail banking unit, which, despite its small scale, saw a 65% increase in revenue in 2011, with deposits up 35% and loans rising 66%.

Banco de la Nación (BN) is the most prominent publicly owned bank, and handles the accounts of public institutions and public sector employees. The bank is also charged with distributing unemployment insurance and welfare payments to low-income and/or rural citizens. In addition to offering savings accounts and credit cards, BN has the most extensive branch network, with an office in every Peruvian province. In recent years, the bank has partnered with MFIs such as Financiera Edyficar to share its office space and offer clients additional microbanking services. In the coming years, BN’s retail operations are likely to further evolve as the Superintendency of Banking, Insurance, and Private Pension Funds (Superintendencia de Banca Seguros y AFP, SBS) recently authorised BN to train and place banking agents in small businesses, such as pharmacies and convenience stores, or bodegas, throughout the country. Known locally as cajeros was also scheduled to open 22 new offices in 2011. Like BN, the big four are continuing to work on expanding their branchless infrastructure by employing more cajeros corresponsales. With 3354 agents as of 2011, BCP is the industry leader in branchless banking, followed by Interbank and BBVA Continental. In the past several years, the big four banks have seen large increases in lending rates and profits. In 2011 lending rates were up 17% and return on equity ranged between 20% and 30%. These banks’ future success, however, will likely depend on their ability to attract a growing number of clients in the face of greater competition.

PENETRATION: As is true for BN and the big four banks, bankarisation, the term for bank penetration, is on the tip of the tongue of all the country’s banking and microfinance leaders. While this has increased over the past six years from 20% to 28%, Peru is still far behind many of its neighbours in this regard. For example, Chile has 70% bank penetration, and for Brazil the figure is believed to exceed 90%. “Rising bankarisation levels are being accompanied by increased access to credit across the country, particularly in areas which had little access to formal credit lines in the past,” René Jaime Fárach, the CEO of CrediScotia, told OBG.

Despite a rapid rise in lending rates, with a loan-to-GDP ratio estimated at 30% by Hugo Perea, chief economist at BBVA Continental, Peru’s financial system remains shallow in comparison to other countries in the region with lower GDP per capita. For example, Nicaragua, one of the lowest-income countries in Latin America, had a loan-to-GDP ratio of 32.5% in 2010. For the banking sector, low penetration rates coupled with rising wages (workers’ income was up 5.4% in Lima in 2011) spells opportunity. Expanding infrastructure and cajeros corresponsales initiatives will play a key role in reaching out to potential new clients.

One major stumbling block to increasing market penetration is a cultural lack of understanding and distrust of the banking sector among the unbanked population. “As a sector, we need to overcome this issue by providing services that inspire confidence in our clients,” said Ana María Zegarra Leyva, the CEO of Financiera Edyficar. Highlighting the sector’s stability and educating clients seem to be the best solutions to this issue at present. Further, while the previously described infrastructure projects may help in reaching new clients, branch building and even cajeros corresponsales may prove insufficient for serving the most remote regions of the country. These are places in the interior that can only be reached by hours of boat travel.

MOBILE SOLUTIONS: Some leaders from the sector hypothesise that mobile banking may prove to be the most adequate, long-term solution for these regions. To this end, SBS is currently working on new legislation that will govern the use of electronic money. The passage of such regulation will pave the way for the expansion of mobile banking platforms.

Currently, the average Peruvian is far more likely to have a mobile phone than a bank account. While bank penetration is around 30%, mobile penetration is over 100%. SBS has stated that it would like to see mobile banking used to facilitate a diverse array of transactions including bill pay and transfers. Further, the regulator is hopeful that with the appropriate technology in place mobile banking could be used to facilitate welfare and other social payments. Such an innovation would greatly reduce the costs associated with transporting and distributing funds, allowing for more money to be invested in other types of social programmes.

Some of the leading MFIs, such as CrediScotia, use mobile technology internally training bank employees to utilise WAP cellular phones to process loan applications. However, Interbank appears to be the only major bank currently offering a sophisticated mobile banking service for customers. SBS plans to present its proposal for legislation regulating electronic money to the national Congress at some point in early 2012.

LENDING RATES: A sharp rise in lending indicates that a growing number of Peruvians are taking advantage of more accessible branch offices and ATMs, as well as overcoming historical distrust to utilise bank services. According to SBS, banking system credit to the private sector was up 16.6% year-on-year (y-o-y) in January 2012, led primarily by large increases in retail lending. While corporate loans grew approximately 18% in 2011, small business loans were up 31.8%. Housing and consumption loans were also major sources of growth, up 29.5% and 30.5% in 2011, respectively.

According to Guillermo Arbe, the chief economist at Scotiabank Perú, “There have been periods in which the main driver of growth was business loans. This was especially true at times when there were a lot of projects geared toward investment in the country. Lately, what we’re seeing is personal loans growing at a faster pace.” Nonetheless, Peru’s extremely shallow capital markets and low interest rates on corporate loans (3.61% on loans denominated in dollars) continue to make the banking sector a crucial source of funding for corporations and large businesses.

DEPOSIT BASE: As lending rates have increased, so have deposits, though not with the same vigour. According to the ASBANC as of December 2011, deposits in local currency were up 7.98% y-o-y, while deposits in dollars grew by 12.51%. In January 2012 overall deposits were up 11.8%, according to SBS. As a result of the lower deposit rates, some banks, such as BCP, have sought external funding through bond issues in 2011.

One factor that could support increased savings in the future is the passage of the Basic Account Law in early 2012. The law allows banks to use cajeros corresponsales for the additional function of opening savings accounts. Until recently the cajeros were limited to performing basic transactions such as bill paying, transfers and withdrawals. Allowing them to accept deposits as well is likely to lead to an increase in the number of microsavings products on offer to low- and middle-income Peruvians. However, to convince consumers to hand over their savings, banks will have to work to overcome the previously mentioned lack of trust common among the unbanked.

INTEREST RATES: Though leaders from the banking sector point out that interest rates have been falling continuously over the last several years, rates on consumer loans remain relatively high by Western standards. As of March 2012, SBS reported average small business loan rates of 27.3% for loans denominated in Peruvian nuevo soles and 16% for small business loans denominated in dollars. Additionally, micro-business loans averaged 32.9% in PEN and 17.9% in dollars while consumer loans were at 35.8% in PEN and 23% in dollars. Arbe pointed out, “We are incorporating a greater number of people that are high-risk as part of growing bank penetration and we need to compensate for this somehow. This dynamic is what keeps average rates high even as some clients that are already incorporated into the system are progressing and seeing their risk profiles and ability to access financing options at lower rates improve.” In general, leaders in the sector believe that interest rates will naturally fall over time as market penetration increases and greater scale allows banks to administer loans at lower costs.

Perea told OBG that macroeconomic conditions could also play an important role in lowering interest rates in the long run. “As long as things continue to go well and Peru maintains a high credit rating on its sovereign debt, the country will be able to issue debt abroad at lower rates. We should be able to internalise these lower financing costs, thus lowering interest rates across the banking sector.” While the idea of capping interest rates is a reoccurring theme in local press, SBS and the central bank, Banco Central Reserva del Perú (BCRP) have both said there is no plan to pursue this at any point in the near future, as many fear that setting ceilings would cause banks to reduce their lending rates and thus impair efforts to increase bank penetration.

DOLLARISATION: One source of concern at the moment is the disparity between interest rates on loans denominated in sol and dollars, which could lead to a greater dollarisation of financial assets. Take the difference in mortgage interest rates. According to SBS, mortgages denominated in PEN had an average interest rate of 9.44% in March 2012 while the average interest rate for mortgages denominated in dollars was 8.13%. Given this obvious incentive, borrowers that are able to may be more likely to take out mortgages in dollars, despite the fact that their incomes are in sol. In this scenario, a dramatic strengthening of the dollar could induce a default on the mortgage.

Despite these risks, the strength and stability of the sol since its creation in the early 1990s, has led the financial sector to experience a sustained period of de-dollarisation since the early 2000s. According to SBS, the percentage of savings and deposits denominated in dollars fell from near 80% in 2002 to 44.9% in January 2012. However, as a result of the US Federal Reserve’s zero-interest rate policy and thus lower interest rates on loans denominated in dollars, the banking sector has seen a slowdown in the de-dollarisation trend.

To mitigate the systemic risks associated with greater dollarisation, the BCRP mandates that banks keep greater reserves on dollar-denominated assets. Higher capital requirements also help increase interest rates on dollar assets and thus eliminate some of the interest rate incentive, though nowhere near all of it. There is only mild concern among banks and regulators about the risks posed by dollarisation, with sector players citing the BCRP’s successful efforts to limit exchange rate volatility. Julio Velarde, the president of the BCRP, recently expressed his confidence in the local currency by announcing to the press that he keeps his savings in sol. While the percentage of assets in dollars would ideally be lower, Alonso Segura, the head of strategy and chief economist at BCP, told OBG, “The central bank has done its jobs in terms of macroprudential measures to minimise any potential for an exchange rate shock.”

REGULATORY COMPLIANCE: Segura’s assurances come as little surprise given Peru’s reputation as a regional leader in terms of sound banking and economic regulation. The sector is generally defined by high capital reserves and high liquidity. As of January 2012, the banking system’s current ratios for assets and liabilities denominated in sol and dollars were at 42.1% and 44%, respectively. Further, equity over risk-weighted assets was at 13.38% in December 2011; this far exceeds the 8% required according to international standards set forth as part of the Basel II and Basel III regulations. Indeed, most banks are already in compliance with the Basel accords. According to Perea, “A lot of the proposals from Basel III have existed in Peru for quite some time. For example, a countercyclical buffer requiring greater capital reserves in times of high credit growth has already been in place for years. The capital recommendations for cyclical risk are also in place.”

From a regulatory point of view, Peru benefits from a banking sector concentrated primarily in the use of so-called plain vanilla financial instruments. There is extremely limited exposure to instruments such as complex derivatives or mortgage-backed securities.

While the European economic crisis remains a concern, leaders from the banking sector are increasingly optimistic in their outlook. According to BBVA research, a serious deterioration in Europe has the potential to affect Peru through a variety of channels including falls in commodity prices and capital inflows as well as stronger pressure on the exchange rate. However, given recent growth, Peruvian banks have been able to build significant capital buffers to protect against both external and domestic shocks. The sector’s performance in 2008-09 is further indication of banks’ preparedness for external turmoil. Perhaps the more important concern for Peru is not Europe, but China. In 2011 China became Peru’s biggest trading partner, with trade between the two countries increasing 32% over 2010. Leading bank executives in the country agree that an unlikely fall in China’s growth rate to less than 5% would pose a threat to the continued expansion of the banking system and the Peruvian economy as a whole.

NEW COMPETITION: For the moment, however, China is interested in supporting the expansion of the banking system directly by setting up a subsidiary of the Industrial and Commercial Bank of China (ICBC) in the country. ICBC is currently considered one of the largest banks in the world in terms of market value.

In early 2011 the bank submitted a request to enter the market. The request was approved by SBS in November 2011, leading the bank to announce that it will be opening a local unit in the first half of 2012. In the early stages, ICBC will focus its activities in corporate finance, a move presumably linked to the increasing number of Chinese mining companies active in Peru.

It is the second institution from East Asia to move into the market. The Bank of Tokyo-Mitsubishi opened its first office in Peru in early 2011. For the moment, the bank is focused specifically in serving the needs of Japanese companies in Peru. Another Japanese bank, Sumitomo Mitsui Banking Corporation, has also expressed its interest in coming to the country. The request is in the earlier stages of the regulatory process.

LOCAL MOVERS: Competition is also coming from closer to home. In 2011 Chilean retail firm Cencosud received permission from SBS to set up banking operations in Peru under the name Banco Cencosud. The company is expected to follow through with this plan, opening its first office in 2012. Cencosud owns two of the country’s most prominent supermarket chains – Wong and Metro – and plans to develop additional retail banking services to complement the retail company’s credit card offerings, which are already available in Peru. The country’s biggest banks are relatively unconcerned by the possibility of new foreign competition cutting into their market share and their profit margins, at least in the short term. All of the big four banks count their long histories in the country and extensive infrastructure as factors that will likely solidify their hold on the market for years to come.

Further, as banking penetration is still at a low level there is plenty of room for growth, at least in the short term, an expanding market may mean that there is simply more business to go around for all banks.

OUTLOOK: Despite the growing number of banking entities that will continue to push for greater penetration, slower economic growth in the coming years is likely to lead to more moderate increases in loan and deposit rates. Peru’s GDP grew by 8.8% in 2010, according to World Bank figures. In 2011 this fell to 7.5%, and forecasts for 2012 are around 6.5%. BBVA research expects that this slower growth will lead to a 14% expansion of bank lending in 2012, down from 17.5% in 2011.

Despite slower growth overall, expanding retail operations will remain the primary focus of the banking sector in years to come. Barring any grave global economic downturns, increases in formal employment and income are likely to continue throughout the near to mid-term. As the number of potential customers continues to grow, personal/consumer and mortgage loans are expected to rise at a rate that will exceed the average increase in lending for the sector overall. On a more macro scale, Segura forecasts that the sector will see growth in the number of regional entities that will operate not only as banks, but financial conglomerates specialising in areas such as asset or wealth management.

In the long run, customers are likely to benefit the most from an ever-expanding bank infrastructure that will allow them to access financial services closer to home and even from their mobile phones. Increasing competition should lead to lower interest rates and a more diverse product offering in years to come, with banks from neighbouring countries such as Colombia and Brazil widely expected to arrive in the next few years.