Banking in Peru remains strong and liquid, emphasising loan growth

Peru’s banking system is widely seen as one of the most stable and well regulated in Latin America. At one level the main banking sector story in 2017 is how this essentially solid services industry will adapt to Peru’s gradual transition from annual growth rates of 7-8% during the commodity boom to a more moderate medium-term average growth rate, with the economy expected to stabilise at around 4-5%.

There is indeed every indication that Peru’s banks will be able to adapt to this new situation while maintaining robust net earnings. However, there is potentially a second and perhaps more dramatic story that could develop in the second half of 2017 and subsequent years. While the banking system is undoubtedly healthy, it is also small, relative to the size of the economy. President Pedro Pablo Kuczynski has therefore spoken of the need for Peru to experience a credit revolution. The president has said that total bank credit in Peru represents no more than 35% of GDP, compared to 80% in Chile or 120% in the US, for example. Kuczynski has therefore set out a bold target to take the value of total credit from 35% to 60% of GDP during his five-year term in office.

Financial Inclusion

The current government is not the only administration to address the problem. Indeed, successive governments have sought to deepen Peru’s financial markets, increase the proportion of the population that has access to banking services, and address the wider issue of financial inclusion and poverty reduction. In this, they have achieved significant progress. One of the key indicators of bank penetration is the ratio of total loans to GDP. This increased from 7.2% in 1991 to 16.1% in 2004 and then to nearly 36% at the end of 2016. There have been some fluctuations reflecting global downturns and the impact of adverse weather patterns, but since 2005 the ratio has been growing fairly consistently. Comparatively speaking, however, Peru remains underbanked in relation to some of its Latin American neighbours. The country is still nearly 10 percentage points below the Latin American average for total loans by value, estimated to be 45% of GDP.

Global Rankings

One of the standard measures of financial inclusion is compiled by the World Bank as part of its Global Findex surveys and refers to the proportion of the adult population (15+ years of age) that has an account in a financial institution. In Peru in 2014 this was 29%, meaning that two out of three Peruvians did not use banks at all. Only 12% of the adult population held a formal savings account. Both numbers were below the Latin American and Caribbean averages, respectively, of 51% and 14%. Another important measure of inclusion has been an annual survey titled “Global Microscope – The Enabling Environment for Financial Inclusion”, compiled by the Economist Intelligence Unit and measuring the framework for financial inclusion across 12 different criteria. These criteria include government support, regulation and supervision of service providers, electronic payments and dispute resolution, among others. Ever since the survey commenced seven years ago Peru has been the top-ranked country, although in the 2016 edition of the report it shared the number-one ranking with Colombia. In that edition both Peru and Colombia scored 89 points out of a possible 100, with India and the Philippines also tied in third place with 78 points.

The report commented on Peru’s progress in launching BIM, an electronic mobile phone-based payments system also known as a mobile wallet (see analysis), which it described as “a positive development in the landscape for financial inclusion”.

One of the challenges is to have a nationwide banking presence. Building one is particularly difficult because Peru is a large country with geography ranging from deserts through to mountain ranges and tropical jungles. By the end of 2016 there were 2149 bank branches operating in the country, more than double the level of 15 years earlier, according to the Peruvian Association of Banks (Asociación de Bancos del Perú, ASBANC). The number of ATMs had increased by a factor of six in the same period to 7650. The number of bank correspondent units – retail outlets where it is possible to conduct bank transactions – increased by a factor of 13 to 50,300. ASBANC calculates that by aggregating all these different types of transactional presence, Peru has 257 banking customer service points per 100,000 members of the adult population – a vast increase from the 10 per 100,000 registered in 2001, but still behind neighbouring countries such as Chile, which had 315 per 100,000 in 2015. Another measure of banking presence is the proportion of the economically active population that has taken out some kind of consumer loan, which stood at 30% in November 2016, up from 21% in 2008. This shows that Peru remains underbanked and therefore retains major potential for expansion.

Review Of 2016

Bank credit has been growing more rapidly than the wider economy in recent years – often at double-digit percentage rates – meaning that market penetration for banking services has been gradually increasing. In 2016 credit growth slowed to 4.43%, according to ASBANC, still above the GDP growth rate of 3.9%. Lending to private households expanded by 6.04%, with overall lending to companies increasing more slowly at 3.64%. Corporate lending to the largest companies grew by 8.98%, followed by consumer loans (+7.42%) and mortgages (+4.57%). Lending to most categories of smaller companies remained flat. Lending to small companies grew by 1.39% and to medium-sized companies by 2.16% but to large companies contracted by 1.09%. By economic sectors, loan growth to companies was highest in real estate, manufacturing, commerce, and transport and communications. Lending to the mining sector, meanwhile, contracted by just under one percentage point.

The context of this solid but slower performance was a year in which domestic demand had a weaker performance than in the immediate past. This in turn led to more sluggish growth in non-primary sectors of the economy, and particularly so in construction, commerce and manufacturing sectors, which traditionally are more reliant on bank finance.

According to the National Institute of Statistics, at 3.9%, the Peruvian economy did grow more strongly in 2016 than in 2015, when it recorded 3.3% expansion, but much of the growth was explained by growth in the mining sector, which traditionally relies little or not at all on local bank credit.

Indicators

The proportion of non-performing loans (NPLs) remained comparatively low at 2.8% in December 2016, ASBANC data shows. It has been on a marginally increasing trend since 2010. Analysts have linked this gradual rise to a slower rate of growth for both employment and consumption levels in the country. The banking system as a whole has comfortably met the statutory liquidity and capital reserve requirements of the financial regulator, the Superintendencia de Banca y Seguros del Perú (SBS). The liquidity ratio in national currency was 27% in December 2016, more than three times the SBS requirement of 8%. In foreign currency terms, liquidity stood at 35.48%, compared to the SBS requirement of 20%. Capital reserves were likewise 121% of the statutory requirement. Solvency indicators such as the capital adequacy ratio (CAR) – capital as a proportion of risk-weighted assets – have been rising steadily since 2008. The banking system’s CAR stood at 15% at the end of 2016, comfortably above both the SBS requirement of 10%, and the Basel III international standard of 8%.

Since the 1990s, both private individuals and companies have been free to choose whether to deposit or borrow in local or in foreign currencies. Given memories of hyperinflation, there were initially very low levels of confidence in the Peruvian sol. In 2002, for example, around 80% of bank lending and 95% of mortgages were conducted in US dollars. However, both these proportions fell steadily in subsequent years as confidence in the national currency was gradually rebuilt. By 2010-12 there was roughly a 50:50 split in the composition of loans and mortgages. By December 2016, 32% of all loans were in US dollars, down from 33% in the same period a year earlier, while 23% of mortgages – down from 27% in the comparable period the previous year – were in US dollars. This modest but continuing de-dollarisation was attributed in part to the fact that in 2016 there was less depreciation of the Peruvian sol and less exchange rate volatility. This de-dollarisation eased off slightly in early 2017.

The banking system efficiency ratio improved, reflecting strong competition between institutions. The ratio measures administrative costs as a proportion of direct lending and has fallen to just over 3.5% at the end of 2016, down from 5.5-6% in 2009-12. Return on equity (ROE) has been on a slightly downward trend since 2011, but remains healthy at around 18%.

In 2016 ASBANC made use of the government’s expanded works-for-taxes scheme to fund and execute a project in lieu of paying taxes directly. The project chosen was an agreement with the Ministry of the Interior to enable ASBANC to refurbish 12 police stations in different parts of the country. This initial work was valued at PEN28.3m ($8.4m). However, the agreement provides for ASBANC to modernise 500 police stations over the next four years. The initiative allows the banking association to position the industry favourably in terms of corporate social responsibility and to show the banks are sensitive to the public’s demand for higher levels of citizen security.

Industry Structure

Peru has both financially healthy and competitive local banks. The top-four institutions are Banco de Crédito del Perú (BCP), BBVA Continental, Scotiabank Peru and Interbank. BCP and Interbank are locally owned, while BBVA Continental and Scotiabank are subsidiaries of global banks based in Spain and Canada, respectively.

Guillermo Arbe, chief economist at Scotiabank, told OBG that the banking system has shown significant and enduring strength since the late 1990s. “We had a small banking crisis in 1998-99, which was followed by a process of consolidation and a change in attitude. The banks got stronger and stayed stronger. They resisted over-extending credit in the good times, because they had learnt the lessons of 1998 and 1999.”

Strong & Healthy

In June 2016 credit ratings agency Fitch Ratings published a review of Peru’s five largest private banks, which between them represented some 89% of total assets in the banking system at the end of 2015. Its report concluded that as a group they had strong and healthy levels of profitability, with revenues well diversified between corporate and retail lending. Bank regulation was described as the strongest in the region, with Peru meeting Basel III standards since 2012. Fitch noted, however, that in the context of more difficult economic conditions, profitability was expected to decline but should continue to compare well among peers.

BCP, the largest bank by assets, is a home-grown institution with a long history in Peru; it began operations in 1889. It currently has subsidiaries in Bolivia, the US, Chile and Panama. By the end of 2016 the bank was operating in Peru through over 6000 correspondent agencies, 2500 ATMs and nearly 450 branches, with a total staff of 17,000 employees. It provides a full range of services across commercial and retail banking and asset management. BCP customers are offered savings products, mortgage loans, credit cards, and services and products focused on small and medium-sized enterprises (SMEs) including credit and leasing. The bank has set itself the target of becoming the number-one ranked financial institution for the quality of its customer service by 2021. It places particular emphasis on developing new digital channels to reach younger customers, such as Millennials – those born between the early 1980s and the late 1990s.

BCP has set up an internal customer-focused digital innovation unit, known as the Centro de InnovaCXión. According to Gianfranco Ferrari, head of digital transformation and retail banking at BCP, one of the changes introduced as a result of work by the bank’s innovation unit is a new tablet-based process for opening an account which takes just four minutes to complete, compared to a total of 20 minutes under the pre-existing procedure.

Ranking Banks

According to FIT Big Data, a Limabased consultancy, BBVA Continental, the second-largest bank by deposits, has the lowest proportion of customers with probability of default, followed by Scotiabank, Interbank and BCP in that order. FIT uses a range of sources, including data from the bank regulator and published corporate information, to compile its rankings. Fitch Ratings on the other hand has also described BBVA Continental as the most “conservative” of the big banks, focusing on blue-chip corporate and retail customers and on risk-weighted profitability rather than on market share. Eduardo Torres-Llosa, CEO of the bank, has previously told local media that its current strategic priority is to improve quality of service through innovation, improved customer experience and digitalisation.

Scotiabank Peru is ranked in third place in terms of both total assets and deposits. In May 2016 Fitch Ratings confirmed its “A-” and “A+” issuer ratings on the bank’s foreign and local currency instruments, respectively. It described the Peruvian operation as a “strategic subsidiary” of the Canada-based Scotiabank group. Fitch said Scotiabank Peru had experienced a moderate deterioration in loan quality as the economy slowed down. There had been a small reduction in profits in 2015 but financial performance would remain satisfactory based on healthy margins, deposit growth and operational efficiency. CARs were strong and compared favourably to those achieved by the bank’s peers. The Peruvian subsidiary does seem to be destined to play an important role in Scotiabank’s global strategy. Brian Porter, president and CEO of the group, told Bloomberg that Scotiabank was reassessing its presence in Asia, where it had just closed its operation in Taiwan and was considering scaling down in Thailand. It was, however, seeking to prioritise the Pacific Alliance countries, including Mexico, Peru, Chile and Colombia, where it expected average economic growth of 3.5% in 2017. Porter said that Scotiabank operations in the Pacific Alliance countries were among the most profitable for the group, followed by those in the Caribbean and then those in Asia. In December 2016 ratings agency Standard and Poor’s raised its long-term rating on Interbank, Peru’s fourth-largest bank, to investment grade at “BBB”, up from “BBB-” previously. The agency noted that Interbank’s capital had been strengthened, with favourable metrics on asset quality. It was projecting that Interbank’s total credit portfolio would grow by 6% in 2016 and by 15% in 2017, with relatively stable interest spreads and effective control of operating costs. In early 2017 the bank had launched a marketing campaign in association with Peruvian rock group Rio to attract “independents” – self-employed Peruvian workers and professionals. To this end it had developed a series of new financial products, including competitively priced health insurance for the self-employed, a cashback credit card and a mortgage loan tailored to the needs of self-employed workers.

SBS reported that the 16 universal service banks operating in Peru earned net profits of PEN7.23bn ($2.14bn) in 2016, an increase of 2.6% on the PEN7.04bn ($2.09bn) of the preceding year. In terms of profit levels, BCP came first with PEN2.93bn ($868.5m), followed by BBVA Continental with PEN1.33bn ($385.3m), Scotiabank with PEN1.2bn ($355.7m) and Interbank with PEN875.1m ($259.4m). Fifth place was taken by Mi Banco, which like BCP is a subsidiary of financial holding company Credicorp, with net profits of PEN312.6m ($92.7m). Making up the top 10 by profits were Citibank, Banbif, Falabella, Ripley and Santander.

Sector Resilience

The Peruvian banking system remained untouched by the wave of concern over corruption that rippled across the country in late 2016 and early 2017, as allegations were made over improper payments by Odebrecht, the Brazilian construction company involved in major infrastructure projects in Peru. Oscar Rivera, president of ASBANC, commented on the issue in March 2017, describing the local banks as totally solid. The banking sector as a whole had the necessary experience and maturity to respond to turbulence, Rivera said. He added that the financial system had sufficient liquidity to respond to any unexpected downturn in economic growth rates caused by a slowdown in infrastructure investment. He also cited recent action by the Central Reserve Bank of Peru (Banco Central de Reserva del Perú, BCRP) to ease cash reserve ratios in national currency and dollars, which would inject liquidity into the system.

In effect, the BCRP had eased reserve requirements in two steps. The marginal cash reserve ratio for foreign currency deposits was reduced from 48% to 46% effective from March 2017, while there was an identical reduction in a special category of local currency-indexed deposits. Earlier, effective from January 2017, the general local currency reserve requirement was reduced from 6.5% to 6%, while the foreign currency marginal ratio was lowered from 70% to 48%.

Relaxing Foreign Investment

The government has also eased restrictions on foreign investment in the domestic banking system. It did so by modifying two articles in the general banking and insurance law, Law No. 26702 (Ley General del Sistema Financiero y del Sistema de Seguros y Orgánica de la Superintendencia de Bancos y Seguros). These had limited cross-bank equity holdings and established that the controlling group of any bank or insurance company cannot own more than 5% of the paid-up capital in another bank or insurance company. However, the new regulations lift those restrictions for international banks listed as first category by the central bank. They are also lifted for domestic banks that can demonstrate that they meet the same criteria. Officials said that the aim of this change was to increase competition in the banking sector and make it easier for international banks to enter the local market.

Towards A Cashless Society

One of the general effects of the expansion of credit, the growth of banking services and the development of technology is a reduced reliance on cash. While in some countries lower reliance on cash is simply a by-product of banking development, a number of policy-makers are now suggesting that having less cash in circulation is a desirable objective in itself. A recent report by the Latin American Banking Federation (Federación Latinoamericana de Bancos, FELABAN) noted that total cash in circulation – notes and coins – in the region in 2015 totalled around $207bn, mostly located in the two largest economies, Brazil and Mexico. Across the region as a whole FELABAN calculated that the ratio between cash (M0) and M1 money supply was 46.1% in June 2016, leading to the broad conclusion that half of all transactions in Latin America are cashbased. FELABAN cited research by Kenneth Rogoff, professor of economics at Harvard University, to the effect that one of the major benefits of increased reliance on electronic payments and reduced reliance on cash is that various illegal activities, such as money laundering and tax evasion, become more difficult. If companies have traceable electronic records for all their payments, it becomes more difficult, for example, to pay staff less than the minimum wage or to evade social contributions. Rogoff acknowledged that lower dependence on cash would have some costs – cybercrime being one of them – but made the case that the benefits exceeded those costs.

FELABAN looked at two case studies. Sweden, a highly developed economy, has been promoting e-payments for a number of years, launching Swish, a zero-cost online payments platform in 2012. Swish is a popular app developed jointly with major banks including Nordea, Handelsbanken, SEB, Danske Bank and Swedbank, and it uses phone numbers to allow anyone with a smartphone to transfer money from one bank account to another in real time. There is strong evidence that encouraging e-payments has helped reduce cash-related crime. Around 80% of transactions are now electronic.

In Latin America, Uruguay has been promoting e-payments, with new legislation introduced in 2014 that emphasises financial inclusion and provides tax benefits for buyers who use e-payment. The authorities there say it is still too early to assess the results.

Although Peru has yet to launch any legislation specifically seeking to reduce the use of cash in the economy, the available evidence suggests it is comparatively well placed to achieve this end.

According to FELABAN’s estimates, in the 12 months to June 2016, M0 grew by 4.7% in Peru, compared to 5.3% growth recorded in Latin America as a whole.

Outlook

ASBANC has a moderate outlook for the sector in 2017. In May 2017 it said it expected loan growth, which had fallen to 4.4% in 2016, to remain at around 4% in 2017. It also expected an associated fall in the NPL rate. ASBANC argues that the fundamentals continue to point to an “enormous potential” for future banking sector growth in Peru. These include the fact that the country has continued growing despite occasional global or domestic headwinds. Poverty rates were decreasing and the middle class was growing, meaning that the banks were able to keep lending to the various market segments. In addition, these institutions had also shown their ability to meet demand for loans, while at the same time controlling loan defaults rates and maintaining adequate levels of liquidity, solvency and profitability.

Alberto Morisaki, manager of economic studies at ASBANC, told OBG that while bank lending has traditionally tended to grow faster than GDP, how much faster depends on the composition of growth. When the primary sector – principally mining – is responsible for the biggest share of GDP growth (as in 2016), bank credit will grow only slightly faster than the economy at large. But when the non-primary sector – and principally private sector consumption – is leading the way, bank credit tends to expand more rapidly. This explained why in 2016 bank credit had grown by 4.4%, only a little ahead of GDP, which grew by 3.9%. In 2017, despite growth being less mining and more consumption intensive, ASBANC was predicting that bank lending would grow by around 4% versus GDP expansion of around 2.5%.

Other analysts were also upbeat about the outlook for the banks, although they noted that the boom years – when the economy grew at 7-8% – are now over and that banks will have to adjust their expectations accordingly. Marco Conteras, a senior equity research analyst at Kallpa Securities, said that Credicorp, the holding company that controls BCP, has set itself the challenge of achieving a 20% ROE, which in a lower economic growth scenario would be challenging.

Roberto Flores, chief strategist and global marco research at brokerage Inteligo, took the view that in order to preserve ROE, the major banks would have to keep seeking out efficiencies and reducing operating costs. There had already been staff reductions in 2016, and banks would be focusing on less costly online marketing channels. He expected BCP to be aiming for 5-8% lending growth in both 2017 and 2018.

BBVA’s Torres-Llosa has also been very positive about medium to long-term banking prospects in Peru. “The number of investors who want to come to Peru is tremendous,” he told Peruvian newspaper El Comercio during an interview in September 2016, additionally stressing the presence of high-quality business talent in the country, as well as financial institutions that are both solid and liquid.

Lastly, while the Peruvian banking system’s NPLs had edged up slightly, the trend seemed to be under control. The new government already had funding in place for its first two years in office, and it had also announced bold infrastructure plans that should contribute to the further development of the sector.