Putting on the brakes: The authorities are taking steps to slow the credit boom

With its expanding middle class and relatively high degree of social mobility, Peru represents a solid growth opportunity for the banking industry. Lending activity jumped by 23% in 2012, with much of this coming from a rise in consumer and retail loans. International players are abuzz with hopes of entering the South American country, and with banking penetration hovering around 30% there is plenty of room for new firms to join the market. Chilean retail lender Banco CencoSud is leading this charge at present, having set up shop in Peru in mid-2012.

However, a rapid expansion in credit has generated some concerns. Non-performing loans (NPLs) are up slightly, and both the sector’s regulator – the Superintendency of Banking, Insurance and Private Management of Pension Funds (Superintendencia de Banca Seguros y AFP, SBS) – and banks themselves are adopting measures aimed at avoiding overheating of the sector and the broader economy.

Growth Areas

The financial system has experienced a significant expansion of credit in a relatively short period. Between June 2007 and December 2012, Peru’s loan-to-GDP ratio rose from 18.95% to 32%. According to Guillermo Arbe, the chief economist at Scotiabank Peru, lending to small and micro businesses has played an important role in this. “These types of loans have always been very dynamic in Peru, and will continue to be,” he told OBG. In June 2013 small business loans grew by 14.1% over the same month in 2012, while credit to micro businesses fell by 3.6%, according to the SBS.

Arbe said that consumer and retail lending are also important contributors to growth. “The social mobility that is occurring means that there is an increased demand for products, as well as a change in the loan structure. People are looking to purchase larger-ticket items, like vehicles, for example. Or as people move from one income level to another, they want a house that is in line with their new status. This explains the rise in mortgages,” he said. Indeed, for June 2013, housing, credit card and general consumer loans climbed by 24.7%, 7.8% and 11.6%, respectively, over June 2012, according to the SBS.

Gustavo Morón, business manager of microlender Financiera Edyficar, said that the growth in housing products extends beyond mortgages, emphasising opportunities to lend for home construction projects. “Home expansion loans are in high demand at the moment. The informal home construction market in Peru is valued at around PEN20m ($7.5m). Financiera Edyficar finances 5% of this market, while the majority of homeowners continue to use personal savings to finance these projects, or seek out loans in the informal market,” Morón told OBG.

Corporate Credit

Corporate credit experienced a relatively minor drop in 2012, declining by 1.5%, after a 13.8% increase in 2011. This was followed by a 7.9% rise in June 2013 over June 2012.

Alberto Morisaki, the deputy manager of economic studies and statistics at the Peruvian Banking Association (Asociación de Bancos del Perú, ASBANC), attributes the slowdown in corporate lending to several factors, including market saturation. “You do not see as much growth in this type of lending because the sector is already well served,” Morisaki told OBG. By comparison, total outstanding mortgages are equivalent to just 4.4% of GDP in Peru, indicating room for expansion that does not exist in the corporate segment. Large businesses also have alternatives to local bank funding, according to Morisaki. “Many corporations operating in Peru can get loans from abroad, and some of the larger companies can also resort to capital markets by issuing equity or bonds,” he said.

Deposit Base

Deposits are also on the rise. According to data from the SBS, as of June 2013 total deposits in the financial system stood at PEN193.9bn ($73bn), an increase of 15.3% over the previous year. Deposits in nuevos soles grew more quickly, up 19%, while dollar-denominated accounts rose by 5%. Results over the past several years also show a longer-term upward trend, with deposits in the financial system as a percentage of GDP climbing from 23.28% in June 2007 to 33.6% in December 2012. This can be attributed to rising incomes, which have allowed more people to save more money. However, Arbe told OBG that this is largely to strong corporate cash positions, and more recently since May 2013, pension fund cash positions.

Correspondent Agencies

This growth looks set to continue as the process of opening savings accounts becomes simpler. At present, a significant proportion of deposits are made at bank service points in pharmacies and small convenience stores. Known locally as cajeros corresponsales, these correspondent agencies are operated by individuals trained to perform a variety of simple bank services, including deposits, withdrawals and transfers.

The Basic Account Law, which was passed in 2011, made it possible for correspondent agencies to expand the range of services they offer to include opening basic savings accounts. For instance, Banco de Cré dito del Perú (BCP), the largest bank in the country as measured by assets, has made a significant push to equip its network of more than 4500 correspondent agencies with this capacity.

While deposits in savings accounts have grown steadily since September 2007 and are predicted to continue to rise with incomes, the Basic Account Law is likely to have a larger impact on savings account penetration than on total deposit levels. This is mainly due to size limitations – the basic accounts opened with correspondent agencies can hold a maximum balance of PEN2000 ($753) and receive up to PEN1000 ($377) in deposits daily. These measures were put in place by the SBS to prevent basic savings accounts from being used for illicit activities.

Interest Rates

The cost of borrowing has declined over the past year in certain market segments, with the average interest rate on mortgages denominated in nuevos soles down by 0.3 percentage points year-on-year (y-o-y) as of July 2013. Rates for corporate business loans denominated in soles of more than one year in tenure increased slightly over this same period from 8.6% to 8.8%, with rates for small businesses dropping by 1.1 percentage points. Yet the rates for other products, including consumer, micro and medium-sized business loans in nuevos soles, have seen more noticeable increases, with the interest rate on consumer loans denominated in the local currency up 1.6 percentage points y-o-y as of July 2013. In the case of medium-sized business loans, this has likely been the result of concerns regarding the overall health of the economy, particularly in light of continued global economic difficulties.

As José Beltrán, a planning manager at CrediScotia, the microfinance arm of Scotiabank Peru, said, “There is less opportunity for lending to medium-sized companies that manufacture for export. This is related to external instability and a fall in sales abroad.” Banking sector leaders reported greater hesitancy when it comes to lending to export-oriented firms.

Banks have also lifted interest rates in response to a steady rise in reserve requirements imposed by the central bank, Banco Central Reserva del Perú (BCRP). In January 2013 the BCRP increased reserve requirements for commercial banks for the fifth time in a year. However, with the announcement that US Federal Reserve would be tapering its quantitative easing programme the dynamics of foreign funding and capital flows changed. In particular, the Peruvian sol began to weaken. Annualised rates for bank credit growth have also fallen to 12%, which is below expectations. As a result, the BCRP began reducing reserve requirements in soles in the second half of 2013 in an effort to promote more orderly growth of credit in the local currency. The policy is likely to continue if the current condition are maintained, though at a different pace. In 2013 the average reserve stood at 20% in June, decreased to 19% in August and dropped further to 17% in September and 16% in October. In addition, a conditional reserve was established to expand credit in foreign currency – with the exception of credit for foreign trade operations – in order to consolidate de-dolliarisation in loans. This additional requirement will apply to credit increases in dollars that are more than 5% of the balance as of September 2013.

Dollarisation

The gap in interest rates between dollar- and nuevo sol-denominated loans, coupled with the strength of the local currency, which rose 5.4% against the dollar in 2012 before slipping back, had encouraged bank customers to take loans in dollars, despite the exchange rate risk it entailed. However, the tapering of the US Federal Reserve’s quantitative easing programme, has changed this. As the BCRP continues with the de-dollarisation process in the credit segment reserve requirements will be reduced by the central bank. In July 2013 loan dollarisation fell from 43% at the end of 2012 to 40.8%, further proof of the prospects for further stabilisation of the pace of credit growth as well greater dynamism in the credit segment for soles. The BCRP stated that the dollarisation ratio of credit in the private sector decreased to 43% in August 2013, a drop of one percentage point from the same month last year.

Less Troubling

However, the phenomenon of dollarisation is less of a concern today than it was in the past. First, the overall trend over the past decade has been toward borrowing in the local currency. As of August 2013 dollar loans accounted for 43% of credit, down from nearly 85% in early 2001. This change is the result of effective management of Peru’s monetary policy and the increased stability of the domestic financial system overall. Moreover, loans in dollars are not available to all bank customers, and most foreign-currency credit is extended to either large companies or wealthy individuals who are aware of the risks involved. “The majority of Peruvians take out loans in nuevos soles, not dollars. Certain segments, such as credit cards, are almost entirely in soles,” Morisaki told OBG. However, there are some notable exceptions, such as vehicle loans, with 76% of this type of debt denominated in dollars as of December 2012. While there was a downward trend in dollarised car loans from 2007 through to mid-2010, this figure has climbed over the past two years or so.

The decline in the overall rate of dollarisation appears to have levelled off, standing at 40-50% for the past couple of years. According to Arbe, this can be linked to US monetary policy. “As long as the spread between interest rates in the US and Peru is large, you are going to have an inflow of dollars,” he said. The BCRP had held the reference rate steady at 4.25% since May 2011, compared to the Federal Reserve’s near-zero interest rate policy. “The issue of dollarisation is something that the BCRP can handle by reducing the cost of lending in soles, as well as making it more difficult to lend in US dollars. With this technique, at some point there is the risk that you will start creating hot money. This is not going to be an easy problem for the BCRP to address,” Arbe said. However, in November 2013 the bank reduced its reference rate from 4.25% to 4%. The BCRP explained that their decision was due to the slowdown in the economy and lower expectations for inflation.

Regulatory Changes

Far from creating hot money, the central bank and the SBS have taken prudent steps to reduce credit growth in the financial system, particularly for dollar loans. The BCRP’s actions have, notably, not involved changing the benchmark interest rate. Instead, it raised reserve requirements five times in 2012 and again in January 2013.

While these changes have applied both to dollar- and nuevo sol-denominated deposits, the former were hit with steeper increases, as the BCRP has worked to control appreciation of the local currency in addition to its efforts to dampen demand for credit.

The SBS has contributed to these efforts through changes in lending regulation, which are designed in part to address the exchange rate risk. Since January 2013, for mortgages with a loan-to-value ratio that exceeds 90% for nuevo sol-denominated assets or 80% for dollar-denominated assets, banks are required to make greater capital provisions. Capital requirements will also be higher for loans that exceed 20 years in length or are for second homes.

Mortgages in dollars are of particular concern, as their value has increased substantially in recent years, rising 7.1% y-o-y as of July 2013. Home lending in general has grown as incomes have increased. Property values are also rising as a result of a housing shortage that some estimate to amount to 2m homes nationwide. In light of these circumstances, regulators recognise that an increase in home loans as well as housing prices is normal. However, the SBS appears to be keen to avoid a real estate crisis like the one recently seen in the US, and has accordingly raised capital requirements for mortgages. While some believe the new lending regulations will cause a mild slowdown in credit growth in 2013, Luis Auqui, the chief of the microfinance supervision department at the SBS, told OBG it is unlikely that the increased capital requirements will have a major impact on credit growth in the short term, as banks are already behaving cautiously and setting aside greater amounts of capital, particularly for loans that carry an exchange rate risk. “This regulation is mainly intended to keep banks from veering off-path,” he told OBG. This could be a challenging task in light of the high level of liquidity that defines the banking system at present.

Pre-Empting A Bubble

Stricter limits on lending should help Peru handle significant capital inflows and avoid a credit bubble. “The lowering of interest rates in the US has sent investors to emerging markets, leading a country like Peru to ask itself how to handle these huge liquidity inflows. We have to make sure that the growth is sustainable, that it does not result in a huge increase in credit with bubble assets,” Hugo Perea, the chief economist at BBVA Continental in Peru, told OBG. “The authorities are acting preventively. We do not have a situation with bubble assets today, but the SBS is trying to ensure we avoid this occurrence going forward.”

NPLS: A slight rise in NPLs has also been a motivating factor behind some of the changes in lending regulations. As of July 2013 the average NPL ratio for the financial system stood at 2.11%, up from 1.72% in July 2012. In August 2012 Barclays Capital speculated that an “aggressive push towards credit cards may have been disorderly, leading to increased asset quality deterioration risks industry-wide going forward.” While the long-term implications of current NPL levels may have been overstated, it is true that as of December 2012, the NPL ratio on credit cards was 4.53%, significantly higher than the average for the financial sector as a whole.

Other areas of concern are small business and consumer loans; according to ASBANC, their NPL ratios were 6.93% and 3.29%, respectively, as of July 2013. However, NPLs for corporate loans and mortgages were small, at zero for the former and 0.94% for the latter. According to Alonso Segura, former manager of economic studies at BCP, NPLs are generally not a major concern. “NPLs are really low in absolute terms if you compare them to our history and other countries in the region,” he told OBG.

It is also important to note that Peru has an especially strict definition of NPLs. For commercial loans, after 15 days’ delay in payment, a loan is considered to be non-performing. A 30-day limit applies to mortgages, consumer and most other types of loans.

Other market participants have noted that an increasing NPL ratio is not surprising given formal banking services are being expanded. “The NPL ratio is rising, but there are two things to keep in mind. First, it is still at a low level. Second, new clients are coming into the system as part of the push for greater bank penetration,” said Perea. “These are mostly lower-income clients who have formal jobs but may not have been working in the same place for years, so they do not have much of a credit history. You could think they are a good client because they have a formal job, but this could be a misjudgement. It is difficult to know whether someone will be a good client when they are new to the system.”

Psychometric Testing

Many of the larger commercial banks and regulators in Peru have begun to look toward non-traditional means of credit evaluation to address the challenge Perea describes. One of these methods is known as psychometric testing, which involves asking a loan applicant a series of questions aimed at evaluating his or her entrepreneurial capacity, intelligence and character.

One of the leaders in exploring the capabilities of psychometric testing in Peru is the Entrepreneurial Finance Lab, an organisation that works in conjunction with the International Finance Corporation, as well as several other prominent partners from the private sector. Psychometric testing, along with adherence to more rigid lending policies in general, is likely to reduce NPL ratios in the long run. While sector leaders were worried about NPL ratios in early 2013, Arbe said that as of late 2013 NPLs had stabilised and that concern was limited to microfinance.

Penetration

Indeed, there is little doubt that efforts to promote banking services are paying off as more Peruvians join the formal financial system, with penetration rates rising along with credit growth. As of December 2012, the percentage of the economically active population with a formal bank loan was up to 34.02% from 29.98% a year earlier.

Some of this growth can be attributed to improved bank infrastructure, which makes it easier for new clients to access services closer to home. As of December 2012 the number of correspondent agencies had increased by 37% y-o-y, totalling more than 14,806 service points throughout the country. New ATMs and branches were also added to the system, increasing by 28% and 10.5%, respectively. According to Morón, the next big challenge will be moving into rural areas. “It is more dispersed in these places, road access is limited and the bandwidth is not so wide, which complicates attempts at communication between rural offices and the headquarters. Also, there is not enough population density to justify a branch,” he told OBG. To address these challenges, Morón cited plans to experiment with mobile branches, essentially a bank in a truck that would move from one town to the next. BCP also opened a mobile branch on a riverboat to serve clients in the jungle area of Loreto.

Regulatory Compliance

New regulations may play a key role in boosting the spread of services. In 2012 the SBS put a new transparency law into effect for banks, requiring the elimination of commissions charged for services, such as performing a credit check as part of a loan application, in order. The purpose is to protect consumers who are new to the system and unaware of bank fees. There is risk in this move. Rene Jaime Farach, the general manager of CrediScotia, told OBG, “Despite the recent hikes, interest rates will be lower by the end of 2014 than in 2013. The increases were caused by banks looking to recoup the losses caused by the reduction of commissions imposed by the SBS.”

On a global scale, Peruvian banks appear ready to meet the Basel III standards. Several market participants noted that in many cases, banks were already in compliance with the latest version of the international regulatory framework, including a requirement to implement a counter-cyclical buffer of greater capital reserves during times of strong credit growth. According to the IMF, the system-wide ratio of Tier 1 capital to risk-weighted assets stood at 10.4% as of December 2011, well above the 7% required by Basel III. Moreover, banks are highly liquid: as of December 2012 the average ratio of liquid assets to short-term liabilities for the banking system as a whole stood at 46.29% in nuevos soles and 46.24% in dollars.

Structure

Peru has 61 financial institutions, including banks, finance companies, non-bank microfinance institutions and leasing firms. There are 16 banks, including the latest entrant, Chile’s Banco Cencosud. More than 80% of assets are concentrated among the top four banks: BCP, BBVA Continental, Scotiabank Peru and Interbank. The microfinance segment is more diverse, with more than 30 players and less market concentration. MiBanco is the largest microfinance entity by loan portfolio, followed by CrediScotia (which is part of Scotiabank Peru), CMAC Arequipa and Financiera Edyficar (part of BCP).

Five of the 16 banks are Peruvian-owned and -operated, including BCP and Interbank. The second-largest bank in the country, BBVA Continental, is a subsidiary of Spain’s BBVA, while Scotiabank Peru is owned by Canada’s Scotiabank. Santander, Deutsche Bank and Citibank are all active in Peru, but they hold a relatively small share of the market. Falabella and Ripley Banks, subsidiaries of Chilean companies, are active in retail lending, as is the newest entrant in the sector, Banco Cencosud, which launched operations in 2012. Cencosud has received permission from the SBS to open 31 offices in eight cities throughout the country, including 22 offices in Lima.

The largest state-owned bank in Peru is Banco de la Nación, which performs a variety of public functions, such as distributing unemployment and welfare payments. It also operates the country’s largest network of branches, with an office in every province. Financiera Edyficar partners with Banco de la Nación to share some of the bank’s offices and offer microfinance products to their clients in common. NEW ARRIVALS?: Several new players are expected to enter the market in the near future. The Industrial and Commercial Bank of China received its licence of organisation from the SBS in November 2011, and its operating licence is currently under evaluation. Other Chinese banks are also thought to be interested in entering the market, but are currently unable to do so as the regulations do not allow the presence of two banks with the same owner – the Chinese state, in this case. US bank J.P. Morgan submitted documentation to the SBS in December 2012 in application for permission to operate in Peru, and this is still under evaluation. Brazil’s Banco Itaú has also expressed its interest in the market, although it had not officially submitted anything at time of press.

Top Dogs

BCP holds approximately 35% of the total banking credit portfolio, followed by BBVA (23.4%), Scotiabank Peru (14%) and Interbank (10.9%). Profit margins for the top banks range from 20% to 35%.

BCP operates an extensive network of branches and correspondent agencies, and is expected to continue to expand its reach to both rural and urban areas. Credicorp Capital was created at the beginning of 2013 through the integration of BCP Capital, Colombia’s Correval, CSI of the US and Chile’s IM Trust. Christian Laub, the president of the Lima Stock Exchange and the CEO of Credicorp Capital, hopes to see it compete to become a leader in asset management, corporate finance, and sales and trading services for Chile, Colombia and Peru.

Meanwhile, BBVA plans on continuing to push for greater market penetration through its microfinance arm, Caja Nuestra Gente, the 10th-largest microfinance institution in Peru in terms of total assets. Perea told OBG that BBVA is also investing heavily to become one of the sector’s technological leaders. “BBVA is implementing all of the newest platforms. We have made significant investments in advancing the technology available to our branches.”

Arbe said that Scotiabank Peru will be reaching out to the middle class. “Peru is experiencing social mobility and is home to an emerging middle class. We are focusing on microfinance, more so than the banking system in general. It is part of the social mobility story,” he told OBG. CrediScotia, the microfinance arm of Scotiabank Peru, is one of the largest microfinance institutions in the country.

Interbank specialises in the retail and consumer segments. The bank, which plans to open 27 new branches in 2013, is also advancing on the technological front and increasing its online presence. In addition, it is making moves to expand its corporate lending operations. At present, Interbank lends to importers and exporters from China and Brazil, maintaining offices in both countries.

Outlook

Leaders from Peru’s banking sector are optimistic about the next few years. Overall, concerns surrounding the possibility of an external shock brought on by slow growth in China, the debt crisis in Europe or other financial system instabilities in the US have calmed since early 2012. Segura predicts that, in the absence of any significant shocks, the economy will grow by more than 6% annually for the next three to four years. The banking sector is expected to expand far more rapidly, however, with loan growth projected at between 15% and 20% in 2013. While the new lending regulations – coupled with rising reserve requirements – could slow activity, a 15% expansion of the credit portfolio would be impressive, especially in light of the ongoing global economic turbulence. The new lending regulations are likely to help ensure the country’s banks are able to maintain more sustainable and healthy growth in the long run.