Latin America's banking system was no stranger to breakdown even before the Mexican peso devaluation spawned the tequila crisis. Even Chile, which has one of the region's most solid banking systems, experienced a serious banking crisis in the early 1980s. Its banks then underwent massive state-sponsored shock therapy and are now completing a thoroughgoing consolidation.
That pattern has been repeated throughout the region to varying degrees. Although devastating devaluations or severe economic instability are often pointed to as the triggers for banking crises, the shaky foundations of national banking systems are more to blame. Poor asset quality, unfocused regulations, bad credit analysis and good old-fashioned corruption erode a banking system long before the walls finally crumble.
Still, if Chile exemplifies the pattern of banking reform in Latin America, golden days lie ahead. Once the shock treatement is over, Latin banking systems will rebound strong and healthy, ready to take on the new foreign competition. If they follow the Chilean example closely enough, Latin America will boast universal banking for the first time in the region's history.
In a recent regional banking report, Santander Investment called the Latin banking crisis "an invaluable learning experience for bank managers, industry regulators and deposit holders." The report concluded: "We also expect overall stronger and wiser financial institutions in coming years throughout Latin America as a result of the recent banking industry shake-outs."
The tequila crisis stands out as the most recent of these shake-outs, one that mainly affected Mexico and Argentina. Although these countries are now clear of the systemic risks the crisis brought, recovery left their banking systems weak. However, now that the regulatory system is generally in order, both countries' banks should grow steadily as their economies bounce back from recession. Argentina has already pulled ahead of Mexico in the recovery process. The Mexican system will be haunted by past-due loan portfolios for years to come.
As a region, Latin American economies grew 6.5% last year and 5% growth is predicted for this year. So far, both Argentina and Mexico have experienced slight increases in production, which signals a nascent recovery from the tequila-provoked recessions.
At this juncture, the key for Latin banks is high-quality growth. The region's banks need to step forward without depending on high-risk lending. Although consumer credit is inadequately catered for throughout Latin America, the region's banks should approach it with extreme caution. However, the allure of such high growth amid stiff competition may prove too strong. The stakes are high and credit control is crucial.
"The next area of rapid loan growth will come in consumer lending, which is by nature high-risk," says Laura Bereja, team leader of the Santander Latin banking study. "As a result, credit controls will become all the more important."
In general, any discussion about the risks of asset growth should be limited to individual countries, and then to the separate tiers of a banking system created by ongoing and recent consolidations. For instance, Chilean banks have grown rapidly without any asset-quality problems. In contrast, Mexican assets skyrocketed in the 1990s with little rhyme or reason. Within a system, as a rule, the larger, stronger banks have the flexibility to move into the consumer lending market. Smaller banks run a higher risk.
Mexico: a long way to go
The tequila crisis hit Mexico hard. In 1995, past-due loans rose 89.5% in dollar terms. Although government support helped reduce the problem, past-due loans will continue to hamper Mexico's slow-growing economy, especially under the new quasi-US GAAP accounting standards which begin in the first quarter of this year.
"You really don't have a normalized banking story in Mexico yet," says Ethan Heisler, fixed-income banking analyst at Salomon Brothers. "There's been no significant levelling in non-performing loans."
Under the previous Mexican accounting standards, because of government debt-restructuring programmes and, to a lesser extent, a slight increase in debtors' cash flows, non-performing loans fell 30% last September from the high of September 1995. As a result of these efforts, the proportion of non-performing loans in the entire system fell to around 7%. If the non-performing portfolios of the 11 institutions in which the government intervened were included, the proportion would rise to 12%. Loan-loss provisions worth Ps19 billion ($2.44 billion) were created by the third quarter last year, which translates into a 91% coverage. If banks that were intervened in are included, it drops to 86.3%.
However, by the first quarter of this year, Mexican banks are required to report quarterly results using a new method that is much closer to international accounting standards. The new standards are expected to have an immediate impact on the amount of past-due loans reported. Under the old method, Mexican banks would only report the unpaid portion of a loan.
Once the new standards take effect, banking income and profits are expected to fall this year. Salomon's Heisler reckons that once what he calls the "Tex-Mex" accounting figures kick in, Mexican banks will report up to 25% non-performing loan ratios.
Although Argentina's banking system has almost finished its recovery, Mexico will feel a little hung over for years to come. Because of long-term loan sales to the government in which the banks assumed 20% to 25% of the risk, Mexico's banks will not be totally free of the tequila crisis for quite some time.
Last September was the official end of the government's Ps13 billion debt-support programme which subsidised consumer and mortgage debt. At that point, Mexico's banks, which the government underpinned for more than a year, were supposed to be on their own. However, while the debt-support programmes may be finished, the government has continued to help the banks capitalize through loan sales, most recently to the country's two largest banks, Banamex and Bancomer, in January.
Earlier this year, the two banks, which have a 43% market share of deposits and loans, announced the sale of Ps8 billion apiece of non-performing mortgage loans to the government. In a mechanism similar to the one used for commercial loans for the past two years, the central bank's savings guarantee fund, Fobaproa, will pay the banks with 10-year notes that are guaranteed by the government and capitalize interest.