Conservative growth: Cautious behaviour has maintained sector profitability for many years

Divided between a national and an international banking system, the Panamanian banking sector was once dominated by foreign banks and global transactions, but now domestic and Latin American institutions are the main players. Despite the sector’s strong performance, large global banks like HSBC and BBVA decided to cease local operations, selling to regional counterparts. With these departures and the lack of a central bank or a lender of last resort, many banks are cautious about lending. Credit remains the main source of income for banks in Panama, and while sophisticated financial transactions are generally avoided, these institutions manage to balance profitability with high liquidity indicators. Despite the departures of well-known names, Panama’s banks have a global focus. Juan Carlos Fábrega, the president of Prival Bank, told OBG, “It is true that commercial banking sector has experienced a regionalisation process. However, private banking is more internationalised than three years ago, partly because of the arrival of new Swiss and Andorran banks.” Furthermore, the banking sector is the main source of credit for the economy and the preferred destination of investment, a positive sign for growth in coming years.

System Structure

Panama has 94 banks that form the International Banking Centre (IBC), composed of the national banking system (NBS) and international banks (IB). The NBS encompasses private and public domestic and foreign banks in Panama. The international institutions carry out transactions completed abroad and are thus isolated from the NBS. To operate in the NBS it is necessary to have a general licence and for IBs, a second special licence. The IBC is composed of two state-owned banks, 51 banks with a general licence, 27 with an international licence and 14 representative offices. The IBC is 76% composed of foreign banks, of which there are 71, while 22 Panamanian banks comprise the remaining quarter. Excluding representative offices, the IBC has 21 Panamanian banks (28%), 37 from Latin America (46%), 10 from Europe (13%), five from North America (6%), four from Asia and Middle East (5%), and two from the Caribbean (3%).

The countries most represented are Colombia (10 banks), Ecuador (5) and Venezuela (5). Of the 50 banks in the NBS, 19 are Panamanian (38%), 20 are from Latin America (40%), five from North America (10%), four from Asia and Middle East (8%), and two are European (4%). The IB sector has 17 banks (61%) from Latin America, eight (26%) from Europe, two from the Caribbean and one from Panama. As growth continues, the authorities hope to make Panama a regional centre for Latin America.

Financing

The banking system in Panama is highly developed. The most recent figures as OBG went to press (2012) showed an assets-to-GDP ratio of 248% for the banking sector in Panama. The credit portfolio and deposits reached 154% and 177%, respectively. For the NBS, total assets were 202% of the GDP and the credit portfolio and deposits were running at ratios of 128% and 151%, respectively.

Total assets of the IBC stood at $96.8bn at November 2013. For the NBS, the total value of assets was $72.9bn and for the IB, $23.9bn. In the third quarter of 2013, total assets reached $97.7bn. The largest part is held by foreign private banks (FPBs, 42% or $41.3bn), followed by Panamanian private banks (PPBs) with 29% ($28.1bn), IBs with 18% ($17.8bn) and official banks (OBs) with 11% ($10.6bn).

Within the NBS, 52% of the assets are held by FPBs, 35% by PPBs and 13% by OBs. The most important component of the assets of the IBC is the credit portfolio, with a share of 64% ($62.5bn), while liquid assets come in second with 17% ($16.4bn), investment in third with 16% ($15.12bn) and, lastly, other investments with a total of 4% ($3.6bn).

The last decade saw a shift in the historical ratios of the IBC’s domestic and foreign assets. According to the “Analysis of the Profitability of the Panamanian Banking Centre” report by the Superintendency of Banks of Panama (Superintendencia de Bancos Panamá, SBP), in the 1970s the ratio of foreign assets was an average of 86%, 84% in the 1980s, 64% in the 1990s, and 52% between 2001 and 2012. In third-quarter 2013, the ratio of foreign assets held by the IBC was 51%, a sign that the domestic market has become the focus. As expected, the IB sector has the highest ratio of foreign assets (98%), while in the NBS the proportion is 41% in foreign assets and 59% in domestic assets. FPBs have 56% of foreign assets, PPBs 24% and OBs 23%. Regarding liabilities and equity portfolios, the numbers are similar. FPBs hold the largest share, at 42%, followed by PPBs (29%), IBs (18%) and OBs (11%). Deposits are the main source of funding, with $70.5bn, which corresponds to 72% of the total (91% of them private), then comes obligations with 14% ($14bn), equity with 10% ($10bn) and other liabilities with 3% ($3.2bn). Domestic deposits reached $40.2bn in the third quarter of 2013 – 57% of the total. With $18bn, PPBs have 45% of domestic deposits, FPBs have 32% ($13bn) and OBs 23%. Concerning international deposits, they reached $30.4bn (43% of the total). FPBs hold 54% ($16.3bn) of the total, IBs 35% ($10.7bn) and PPBs 11% ($3.2bn). The participation of IBs on domestic deposits as well as the OBs on foreign deposits is close to zero. Credit operations are the main source of income for banks in Panama. From January to September 2013, the IBC’s total income was $4.5bn. Interest generated by loans ($2.6bn) was responsible for 58% of this, other sources 12%, commissions 11% and dividends brought in 9%. Regarding expenses, interest payments were the main component, responsible for 42% ($1.4bn) of the total. Administrative expenses were also a large share, reaching $793.5m (23%). The composition of assets and liabilities of the NBS follows a similar pattern, with roughly equal shares.

Performance

The Panamanian banking sector has benefitted from the country’s overall economic growth in recent years, showing a strong and stable performance. From the third quarter of 2012 to the same period in 2013 there was an increase of 12% in total assets. The component with the highest growth was liquid assets with 22%. However, the most important element of the growth in total assets was credit, as it has the largest share of assets (64%) and grew by 12.5%, accounting for 65% of total asset growth. The growth of assets in the NBS was very similar, at around 13%. The liquid assets portfolio had the highest growth rate, at 17%, but as in the case of the IBC, the credit portfolio was the most important component and was responsible for 70% of the NBS’s asset growth. In both the IBC and NBS, the growth of equity and liabilities resulted from the expansion of deposits. As they have the largest share, their growth corresponded to 82% of the expansion in assets and liabilities of the IBC and 77% of the NBS. The profits of the IBC were not as strong, however, growing by only 1.2% in the 2012-13 period, to $1.1bn. Total income was up by 8%, from $4.2bn to $4.5bn, but total expenses rose faster, from $3.1bn to $3.4bn, an increase of 10%. As a consequence, the IBC showed poorer profitability indicators. According to the SBP’s banking report, from September 2012 to September 2013, there was a decrease in the return on assets (ROA) of the IBC, from 1.76% to 1.59%, and the same for the return on equity (ROE), which fell from 15.3% to 14.6%.

For the NBS there was a decrease of 4.8% in profitability. While expenses grew at a pace of 12.9%, income growth was only 6.5%. Operational expenses went up by 12% and general expenses by 15%, while income from interest grew by 10% and other income dropped by 1.3%. OBs and FPBs had their profits reduced by 22% and 19%, respectively, and PPBs saw an increase of 9%. IBs had an outstanding performance with profits growing by 56%.

Regulation

One of the most distinctive features of the Panamanian banking sector is the lack of a central bank. The supervisory and regulatory function is carried out by the SBP, created in 1998. A replacement for the National Bank Commission, it is responsible for maintaining the stability, confidence and competitiveness of the banking system. The commission has administrative and financial autonomy, and its resources come from banking and supervisory fees. The work done by the SBP is well regarded by people from both private and public sectors.

Carlos Troetsch, president of the Panamanian Banking Association (Asociación Bancaria de Panamá, ABP), told OBG, “We have effective regulations and one of the most important features of our system is that regulators and banks have a relationship – banks always have the opportunity of expressing their opinions on issues, providing comments and suggestions about areas of regulation.” The importance of banks’ participation in drawing up regulations was also highlighted by Luis Hurtado, general manager of the Banco Hipotecario Nacional.

As part of the recent changes and efforts to improve regulation, Panama adopted the Uniform Risk-Based Supervision Manual (MUSBER) in 2012, developed in cooperation with the Inter-American Development Bank (IADB). According to MUSBER, the regulator identifies a bank’s risk profile according to the exposure of its assets and liabilities to swings in capital flows, interest rates and other risk factors, and develops a supervision strategy based on this profile. According to the SBP’s 2012-14 strategic plan, the MUSBER methodology is expected to be adopted for the supervision of the whole IBC in 2014. It has also adopted international standards such as the International Financial Reporting Standards (IFRS) and the Xtensive Business Reporting Language (XBRL), and was supplied with new technology to carry out inspections of the different banks. Another important change being implemented and timed to take effect in 2014 is the dynamic provision, a countercyclical instrument in which provisioning is increased during times of high liquidity and reduced when liquidity is low.

The improved regulatory environment and accompanying technical improvements have primed the sector for growth in new directions. According to Ernesto Boyd, executive vice-president and general manager of Metrobank, “With the regulation ready in Panama, the use of cell phones to pay invoices is another opportunity that banks need to start exploring.”

Strategic Planning

The Financial Coordination Committee (Consejo de Coordinación Financiera, CCF) was established in 2011 to strengthen the supervision of the banking and financial sectors. It is composed of members of different regulatory agencies (banks, insurance and reinsurance, and capital markets) and of the Panamanian Autonomous Institute of Cooperatives, the Ministry of Industry and Trade, and the Public Sector Workers’ Pension Funds. Among its objectives are improving coordination and the exchange of information among the different financial sector supervisors, harmonising regulation and developing common supervision over financial groups.

The CCF’s 2013-15 strategic plan includes initiatives such as a programme of financial education (to take effect in 2014) and the development of a methodology or manual for macroprudential regulation (to be done by 2015). Although a report from the IMF identifies the creation of the CCF as an improvement in regulation, it also said coordination among regulators has to be improved and that it is necessary to empower it with a clear mandate to ensure financial stability. According to the same report, another important requirement is the creation of a liquidity facility, whose main function would be to act as a lender of last resort. Such an instrument is seen as necessary because despite the resilience shown in past years and the high liquidity in banks’ balance sheets, the system could still be vulnerable to large systemic liquidity shocks. The IMF’s Article IV staff report points that private sector credit growth could be vulnerable to capital flights from Latin American or a slowdown in countries like Colombia and Venezuela, important sources of foreign deposits. The mechanism would begin with smaller amounts until the provision of resources could be made, given the difficulties of creating a lender of last resort in a country which does not issue its own currency. The creation of the liquidity facility is under the responsibility of the Ministry of Finance. Supervision will be enhanced by identifying systemically important banks and macro-prudential and systemic risks. In addition, as part of the adoption of recommendations from the IMF’s 2011 Financial Sector Assessment Programme (FSAP), the SBP initiated a quarterly financial stability report.

Commenting on the creation of a liquidity facility, Jose Abbo, financial advisor and member of the board of directors of the Panamanian Sovereign Wealth Fund (Fondo de Ahorro de Panama, FAP), believes the degree of development, the size and the interconnectedness of the system mean it must have such a mechanism and suggests there is a need for something like an institution to mitigate the impacts of systemic risk.

“You cannot wait for something to happen before creating a mechanism like that,” he told OBG. However, Abbo said, a liquidity facility does not have to be a traditional lender of last resort – a central bank that prints money. “It is necessary to think out of the box, to create a mechanism like a fund created by private banks with the help of the SBP,” he told OBG.

This last opinion reflects the widely held view that the sector’s stability results from the cautiousness of players in the absence of a lender of last resort. Currently, the creation of a last-resort mechanism seems to raise fears of the rise of moral hazard. The banking sector in Panama has traditionally been cautious and responsible. According to Troetsch, “The strength of the banking sector is connected with our tradition of self-regulation. By being self-regulated, banks have been very conservative in lending to different sectors.”

The same view was expressed by Javier Motta, head of financial statistics at the SBP, who believe the good behaviour of the banks is related to fear of failure. However, these opinions on self-regulation have not translated into opposition to a lender of last resort.

Other issues raised by the IMF in its report on Panama include the necessity of improving data provision and the regulation of non-bank institutions, like savings and loans and cooperatives.

International Cooperation

To accomplish its goal of becoming a financial centre, Panama has been working to shed its image as a tax haven. The country is cooperating with international institutions such as the Bank for International Settlements, the Organisation for Economic Co-operation and Development (OECD), the IMF, the IADB, and the Central American Council of Superintendents of Banks, Insurance and Other Financial Institutions, providing statistics and information and receiving technical assistance on different matters to improve transparency and supervision of the banking system. Panama also provides monetary and financial statistics to the Central America, Panama and Dominican Republic Technical Assistance Regional Centre to harmonise statistics and facilitate regional analysis. The SBP’s strategic plan for 2012-14 involves improving corporate governance and compliance with international standards to curb illegal activities (such as terrorism and money laundering). This effort has also involved improvements in the legal framework for anti-money laundering and combatting terrorism financing.

In 2012 agreements of cooperation and exchange of information were signed with Peru, Uruguay and Andorra. In March 2013 a tax information exchange agreement was signed with Canada. Panama has also signed many other tax information exchange agreements and 12 double taxation treaties with various countries. It was because of efforts like these that the country was removed from the OECD’s “grey list” in 2011. Locals and foreigners in Panama from the public and private sectors are unanimous in stating that Panama is not a tax haven. They recognise, though, that outside Panama it is still seen that way, which may remain a significant obstacle to growth.

Promotion

Thus, there is a joint effort from the public and private sectors to promote the country around the world, not only publicising the advantages of setting up in Panama, such as well-developed IT infrastructure, the dollarised economy and the free flow of capital, but also of the efforts being made in regulation and supervision. Although recognising authorities have been carrying this task, Corina Grimaldo, former director of financial studies at the SBP, said that more needs to be done. “It is very important for the authorities to go around the world and tell people how the system actually works and to publicise all the actions being taken” she told OBG. So, more than reform measures themselves, there is a need to improve the image of the country internationally.

Outlook

As credit is the main source of income, the performance of banks operating in Panama is linked to the overall performance of the economy. The banking sector has benefitted from high economic growth over the past few years, showing a strong and stable performance. Assets, deposits and credit are still growing, although profitability indicators are showing signs of deceleration. Large investments in infrastructure boosted economic growth in recent years, and the performance of the next few years will depend on the continuity of such investments. For 2014, Eduardo Quirós, manager of financial stability at the SBP, told OBG that the sector is expected to maintain its strong pace of growth, but there may be a small slowdown due to the presidential elections, which are set to be held in May 2014. “Historically, in such periods banks get more cautious due to the uncertainties political shifts bring,” he said. In a context where many jobs – especially those connected to public sector work – and overall economic performance depend on who will be elected, banks tend to be more careful about granting loans.

The creation of the liquidity facility could represent an important turning point for the country. Self-regulation was able to generate a sound and safe system. High liquidity indicators are a good thing, but when they are too high, they may be better for the banks themselves and shareholders than for the economy. A liquidity facility could enable banks to adopt a more aggressive strategy and work with lower liquidity and capital ratios, which could mean more credit for the economy and higher economic growth.

There may still be room for the successful features of self-regulation to coexist with a liquidity facility, without risking the system’s soundness. Regarding the IB sector, despite the recent efforts to shed the country’s image as a tax haven, there is a general consensus that more has to be done to attract large international banks. This is not only down to matters of regulation, but will also require improving the image of the country abroad and showing the stability and the soundness of the Panamanian banking system.