From the Rio Grande to Tierra del Fuego, many Latin American banking systems are today in a state of convulsion. Up and down the continent, banks are restructuring their portfolios or unloading bad debts on the state, merging or being taken over, or just plain going to the wall.
The themes are often the same but the underlying causes are specific to each country. In Mexico, banks have been knocked sideways by mounting bad debts caused by the skyrocketing interest rates that followed Mexico's currency devaluation in December 1994. In Brazil, Latin America's biggest economy, the financial sector is recovering from last year's government-imposed credit squeeze and adjusting to life without hyper-inflation. In Argentina, where banks also enjoyed years of very high inflation, the sector has undergone a rapid consolidation, with scores of weaker banks taking their last gasp in 1995 as liquidity drained from the system. Even in booming Chile, where the economy is still growing at 7% a year, there is something of a shakeout in the financial system.
"Latin America's banking systems are at very different stages," says Geoffrey Dennis, Latin American strategist at Bear Stearns. He maintains that "the common, continent-wide theme of rationalization and consolidation" is less relevant than the specific dramas unfolding in individual countries. "The differences are more important than the similarities." For example, says Dennis, Mexico's financial system - which he considers still to be in "deep trouble" - had by end-1995 an average ratio of past-due loans to assets of 18%. By contrast Chile, which went through its Mexican-style banking crisis in the early 1980s, has an average bad-debt ratio of only 0.9%, with some quoted banks, such as O'Higgins (at 0.52%) enjoying "stunningly good asset quality".
"These are the two dramatic extremes," says Dennis. "In the middle you have the two other big banking systems: Argentina, which was affected by last year's huge outflow of deposits [to the tune of $8 billion] and a slowing economy; and Brazil, which last year had very high interest rates and where two major banks have already gone bust. These two systems are in better shape than Mexico's, but they still have their problems."
It is Mexico, however, that presents the bleakest picture. In spite of a recent rally in Mexican bank stocks, most analysts concede that the financial system is still in the throes of crisis. In 1995, the government spent an estimated P84 billion pesos ($11 billion), or about 5% of GDP, on debt-relief and recapitalization schemes to stave off banking failures. But the state will have to dig deeper still if it is to keep the system solvent. Experts say a further 7% to 10% of GDP will need to be injected over the next decade.
"Mexico's banking crisis remains systemic," says Laura Berdeja, Mexico City-based head of Latin American bank research at Santander Investment. "It resulted, in large part, from the macro-devaluation of 1994 which pro-duced a higher interest-rate environment and volatility in the financial markets. Because the driving force of the crisis was macro-economic, all banks were badly hit." Most of Mexico's loans are floating rate, so when interest rates went through the roof, many borrowers simply could not meet their payments.
Bad debts mount up
Last year, as interest rates quadrupled, past-due loans more than doubled to P120 billion, reaching 17% of total loan portfolios by the end of September. Problem loans grew to more than twice the banking system's entire capital base. Difficulties were compounded when, with Mexico's currency in free-fall, international banks called in their credit lines. In 1995, five banks, including the big institutions Inverlat and Banpais, were placed under central bank administration.
Last year's crisis was the culmination of problems that had been mounting since the early 1990s when 18 banks were privatized. Weak regulation, self-lending and lack of credit-risk analysis led to an explosion of credit and a consequent escalation of non-performing loans. Moody's was already concerned before the devaluation, writing in a 1994 report: "The system's ability to adjust to a liberalized banking environment has been hindered by a lack of experienced management, poor borrower disclosure, the absence of a strong credit culture, the paucity of credit bureaux and close links with concentrated industrial sectors."
Last year, faced with a teetering system, the government launched a rescue package agreeing to take over banks' non-performing loans if they made a commitment to inject fresh capital. Last December, Banamex, Mexico's biggest commercial bank by assets, became the eighth institution to participate in the rescue scheme. It sold P15 billion of its non-performing loans to the government - 12% of its loan portfolio - in return for agreement by Banacci, the financial group that owns Banamex, to inject more than $1 billion of new capital. A similar transaction in June saved Serfin, Mexico's third largest bank, from technical insolvency.
Despite such bail-outs, bad debts continue to mount. The authorities may have cleaned up some of the bad loans generated in 1995, says Dennis, but with the economy still fragile, defaults will continue to climb this year, creating a whole new set of problems.
Banamex was by no means alone in seeing its past-due loans rise by 19% in the fourth quarter of 1995, Dennis says. "Asset quality can still deteriorate further."
Brian Pearl, banking analyst at Smith Barney, recently downgraded Mexican banks, saying he was even more pessimistic than most of his colleagues. "I don't think things are going to get out of control," he says, discounting the collapse of any large banks. But, he believes, investors should now be asking themselves about banks' future profitability. His view is that profits will be negligible over the next two years, as nominal advances are eaten away by inflation.
Consolidation
Berdeja is also cautious on Mexican bank earnings, partly because of the adoption next year of stricter US GAAP accounting rules. Under the new criteria, banks will be able to wait slightly longer before classifying a loan as non-performing, but will then have to write off the whole amount, not just the unpaid installments that current guidelines require. "Once US GAAP rules kick in from January 1997, the bank numbers could well look worse. If past-due loans increase, reserve creation will have to rise, which will result in a drag on earnings."
There is a glimmer of hope. Some foreign banks have shown an interest in recapitalizing or even taking over struggling Mexican institutions. The Bank of Nova Scotia, for example, has agreed to purchase 55% of Grupo Financiero Inverlat, Mexico's fifth biggest bank, for $225 million. (Scotia already owns 8% of the bank.) Last December, Inverlat was rescued by the government from insolvency when shareholders failed to reach agreement on a recapitalization plan.
Similarly, the Bank of Montreal has signed a letter of intent to buy 16% of Grupo Financiero Bancomer, which owns Mexico's second largest bank, for between $426 million and $480 million. In order to qualify for the government rescue package, Bancomer needed to find a partner willing to inject $500 million of fresh capital. Foreign interest in Mexican banks even runs to small institutions such as the Banca Cremi, which was taken over by the government in 1994 following allegations of fraud. In February, no fewer than 15 foreign and domestic organizations were believed to have expressed interest in buying the bank.
The precedent has already been set. In June, Banco Bilbao Vizcaya of Spain became the first foreign bank to take control of a Mexican institution when it injected $350 million of fresh capital into Probursa. In return, the government took over $800 million worth of Probursa's problem loans.
"The injection of money by foreign banks is very positive news," says Dennis, who believes that a private-sector bail-out is far preferable to rescue from the public sector. "The problem with virtually all the solutions put forward [so far] to tackle Mexico's banking crisis, is that they involve government money. There's no free lunch here." As well as costing the Mexican state huge sums of cash that it can ill afford to spend, state intervention effectively spells partial renationalization of the sector, he says.
Brazil's government, like that of Mexico, has also been forced to intervene to ward off potential banking collapse. But the crisis there has been largely provoked by different factors. First, Brazilian banks, which mushroomed during the easy-money years of hyperinflation, had to adjust to a lower inflationary environment after the launch of the real stabilization plan in July 1994. Then, as unleashed pent-up demand threatened to overheat the economy, the government throttled money supply and imposed tougher reserve requirements, driving up interest rates to a real 50% a year.
For several institutions, the double test proved too much. The most spectacular collapse was perhaps that of Banco Economico, the eighth largest private-sector bank, in which the central bank intervened last August. It had been rumoured for months that Economico was in trouble, but only shortly before it was taken over (with negative net assets of $1.5 billion), the bank had released audited interim results showing healthy profits. Its sudden collapse, aside from shocking many of its depositors, raised disturbing questions about Brazilian banking supervision and the quality of financial information.
The liquidity problems that brought Economico to its knees had already claimed two victims: Banco Mercantil de Pernambuco and Banco Commercial de Sao Paulo. Later in the year, the crisis would wreak similar havoc at Banco Nacional, one of Brazil's biggest commercial banks, forcing the central bank to take special administrative control.
In all, 17 institutions have been liquidated since price stabilization. "In Brazil, banks had been making a large part of their money on the float [inflation differential], but this is no longer so profitable," says Berdeja. "They are having to go back to traditional banking activities such as lending, but the risk is that their credit skills are rusty."
Jose Garcia-Cantera, banking analyst at Salomon Brothers, says that as the economy cooled in the second half of 1995, bad debts and corporate bankruptcies mounted fast. Banks suffered "huge asset-quality problems", he remembers. But, following a relaxation of monetary policy, there is anecdotal evidence to suggest that problem loans may have peaked in September and then started to drop from December.
What is now likely to follow is a process of mergers and acquisitions which many experts believe will bring the number of banks down from the current 240, to as few as 100 or 150. Banks proliferated following a 1988 banking law revision that led to the creation of some 130 universal institutions, many of them small and medium-sized. The consolidation process, occurring in Argentina and Chile, and soon expected to reach Mexico, is one of the common themes of Latin American banking. Most notable of the Brazilian bank mergers to date is that of Unibanco, which is to buy the assets of the failed Banco Nacional, formerly one of its main rivals. The fusion will create the second largest private Brazilian bank and one of the biggest in Latin America, with total assets of more than $24 billion and a net worth of $2.5 billion. Unibanco is likely to close down up to a third of Nacional's 335 outlets to avoid overlap with its own 460 branches. Several other deals are in the pipe-line, such as the takeover of Banco Economico by the much smaller Banco Excel, and the merger of Bandeirantes with Banco Banorte.
In the public sector, where solid banking practices often come a poor second to politics and influence-peddling, the picture is grimmer. By June last year, the ratio of non-performing loans to assets of the state banks had reached 12%, compared with 6.8.% in the private sector, according to Adriana Lacombe, a Sao Paulo-based banking analyst at ING Barings. Worse still, bad debts at state-owned Banco do Brasil, Latin America's largest bank, are estimated at a staggering 27%.
Banespa and Banerj, the state banks of Sao Paulo and Rio de Janeiro respectively, both succumbed to mounting difficulties and have had to be rescued. Banerj has been put under the administrative control of Banco Bozano Simonsen which will prepare it for privatization over the next year. The state of Sao Paulo has blocked a similar solution to the woes of Banespa which, after making use of loans it could not afford, needs billions of dollars of fresh capital. The state will take over some of the bad debts and refinance the rest by issuing long-term bonds. The Banespa solution does not please many experts who believe that privatization is the only sure means of keeping politicians' fingers out of Banespa's till.
Considering the terrible shocks dealt to Brazil's financial system, however, some commercial banks appear to have escaped fairly lightly. "There is still a crisis, but the worst part of it has gone," says Lacombe.
The resilience of Brazil's banks is partly due to their considerable technical and managerial capabilities, which were developed, ironically, during the hyper-inflationary years. In the days of raging inflation, a bank had to know how to take a deposit in the Amazon, calculate the account's almost hourly variations and be ready to pay the customer back at a branch in, say, Brasilia or Sao Paulo. The result was the installation of technology that was far in advance of that present in most Latin American countries.
Bradesco, for example, is a universal bank which lends to most sections of Brazil's economically disparate society. It has 2,000 branches, more than 10 times the 180 branches of Argentina's largest commercial banks. But rather than becoming a monolith, Bradesco has for 10 years been making sharp efficiency gains, cutting staff from 140,000 in 1986 to 52,000 by the end of last year. In Brazil's new banking environment, there is now an even greater need to squeeze profits from efficiency gains, rather than increasing exposure to potentially bad-risk borrowers. Bradesco intends to cut employee levels by a further 7,000 this year.
If swift changes are underfoot in Brazil, things are moving at positively lightning speed in Argentina. Almost overnight, a quarter of the country's 200 banks have disappeared. Like Brazil, Argentina witnessed the sprouting of banks during its years of very high inflation, when arbitrage and crafty trading generated handsome profits. After price stability in 1991, most of these institutions hung on for dear life. Until just before Mexico's devaluation, customers in a medium-sized Argentine town could take their business to perhaps as many as 40 banks. Not any more. When Mexican shock-waves began to reverberate through Argentina, panicked depositors withdrew $8 billion almost overnight, representing 18% of the entire financial system. Many banks, still in their old trading habits, were also holders of plummeting Argentine paper. These were the institutions to tumble first.
Early in the year, the central bank suspended a handful of banks, while many others stayed open even though they had long ago stopped returning customers' deposits. The government, fearing the rot would spread to the rest of the system, persuaded healthy banks to set up a deposit-guarantee scheme to calm investor nerves. Because of Argentina's currency board system, which limits money supply to foreign currency reserves, the state was forbidden by law to mount a Mexican-style bail-out operation.
Fortunately, the run on banks stopped. Domingo Cavallo, the economy minister, seized the opportunity by constituting two banking fiduciary funds, borrowing the money from multilateral institutions and via the issue of $2 billion worth of domestic and international bonds. Healthy banks that agreed to take over weaker institutions were promised cash to help them clean up the mess. The second fiduciary fund was exclusively for state-owned provincial banks, many of them effectively bankrupt. Money would only be available to these banks if they immediately initiated privatization proceedings.
In spite of some mistakes - including a cash injection into the Rosario-based Banco Integrado Departmental, which subsequently had to close - most analysts say the central bank has overseen a fairly painless consolidation.
Roque Fernandez, president of the nominally independent central bank, said at the time that the government faced "a transitory crisis" of illiquidity. "We acted with the available implements to inject liquidity through the reduction of reserve requirements [which had previously been prudently high] and by trying to facilitate all transfers of portfolios so that those entities with excess liquidity could transfer liquidity to those that were lacking." Typical in this consolidation process was the case of Banco Shaw and Banco del Sud which cemented their marriage (arranged before the Mexican crisis) late last year. Once fused, the new-look BanSud snapped up 30 additional branches that had once belonged to the suspended Banco Federal. In another example, seven struggling cooperative banks, whose agricultural loans had gone sour, fused to become Banco Bisel. In January, France's CrŽdit Agricole agreed to take a 20% stake in Bisel. Banco Boston, one of Argentina's most important foreign banks, used the consolidation frenzy to take a decisive step into the retail market: it took over 93 branches and $200 million worth of assets belonging to defunct Banco Integrado.
Between mergers, privatizations and bankruptcies, some 50 banks have disappeared. Big banks have benefitted, as wary depositors have concentrated their money in the top 20 institutions, leaving the smaller banks to scrap over the remainder.
Martin Pradier, head of research at James Capel in Buenos Aires, believes the process "still has a considerable way to go". He says: "Argentine banks are too small. If you look at Canada, they've got six big banks which account for most deposits. In Argentina, 10 important banks have approximately 60% of deposits and it doesn't make sense for the others to have only 40%. There isn't enough business to go round."
Pradier doesn't foresee any big dramas in the continued rationalization process. Indeed, for large banks, things are getting easier: "The risk of lending to Argentina is much lower now than it was six months ago and you are beginning to see some of the big banks going abroad to borrow money." By the end of January, all the $8 billion that fled the system in 1995 had returned. Many analysts are now predicting that deposits will grow by a further $6 billion to reach $50 billion by year-end. "It's too early to declare victory," says Berdeja. "But there have been positive developments such as the return of foreign flows. We are estimating a 15% growth in loans for 1996." The latest results from Banco Frances, Argentina's fifth biggest commercial bank, showed loan growth up significantly. This process of expanding loans should be helped, say analysts, by changes in Argentine reserve requirements, though consumer spending is expected to continue very weak during the remainder of this year.
"The strategy of banks will be to try to penetrate the lower middle-class income sector," says Pradier. "Banks have been lazy, with profits made largely on the trading side. Even at Galicia [the largest commercial bank] and Frances, 40% of earnings have come from trading. Now they will have to move more into retail."
Battle for retail custom
As with consolidation, the pursuit of lower-income retail customers is a regional trend. "Across the board, with the exception of Mexico, there is a movement down-market," says Pearl. "Continent-wide, this move down-market is a necessary step. But in the initial stage, I favour banks that already have experience in this type of lending." Given often high poverty levels in Latin America, Pearl says banks should ask themselves: "Do we really understand what it means to seek higher margins on necessarily riskier loans?"
Last August, Salomon Brothers produced a guide aimed at establishing a "safe" level of loan growth, using bank penetration and macro-economic performance as its main variables. Defining penetration as "loans to bankable GDP", it found that over a three- to four-year period, Argentina's penetration was 23.4%, Brazil's 28.4%, Chile's 49.7% and Colombia's 21.4%. Loan growth against GDP growth over the same period was 2.2 times for Argentina, 5.6 for Brazil, only 1.6 for Chile and 4.1 for Colombia. Mexico, where asset-deterioration has been the worst on the continent, scored 38.4 for penetration, while loans grew 9.6 times as fast as GDP.
"It is evident that Mexico experienced loan growth rates that were unsustainable in the long term," say the authors of the report. "We believe that the asset quality problems derived from those huge growth rates (which have to date been only partially recognized by the Mexican banks) will remain in place for many years." Brazil and Colombia were "slightly too aggressive" in loan expansion over the same period, while Argentina and Chile show sustainable loan growth levels, according to the report.
Apart from Venezuela, whose banking crisis was unique for preceding Mexico's devaluation, the banking sectors in the region's other sizeable economies appear relatively stable when compared with those of Mexico, Brazil and Argentina. But this does not mean changes are not afoot. In Chile, Banco O'Higgins, the third largest commercial bank, and Banco de Santiago, the second largest, are due to merge after O'Higgins's bid to raise its stake in Santiago by between 25.5% and 51%. The merger, says Pearl, could result in a bank with 17% market share. Since 1991, the number of Chilean institutions has fallen from 40 to 31.
Earlier last year, Antofagasta Holdings, the London-quoted company which owns O'Higgins, signed a deal with Banco Central Hispanoamericano of Spain, aimed at creating a banking network with assets of $10 billion.
As Chilean banks have lost business with corporate clients, which increasingly are raising their own capital through equity and bond issues, the battle for retail customers in Latin America's most solid banking system has intensified. Only 30% of Chileans have bank accounts at the moment, a factor which leaves room for expansion. "In Chile, the move down-market is very strong with a lot of banks trying to increase their consumer lending," says Pearl.
The Colombian banking system, one of the continent's best regulated, is bracing itself for economic reverberations should the political trial of president Ernesto Samper drag on and weaken growth prospects. But so far the system has seen no greater drama than the slow development of universal banks as a once highly segmented sector is liberalized.
"The [Colombian] banking system was previously regulated on a niche basis," says Pearl. "That has been peeled away slowly and you can see the big banks spreading. Ganadero [the biggest bank] has just entered the insurance business, for example. These banks are al-ready highly profitable. They are moving into other areas because the regulatory barriers are being lifted and it's natural for them to do so."
The other nascent trend that has captured analysts' imagination is evidence that one or two banks are beginning to have regional ambitions. Chile's O'Higgins, for example, has taken stakes in banks in Argentina and Peru. More dramatically, Brazilian bank Itau, considered to be one of the continent's best managed, is establishing a big branch network in Argentina, Brazil's principal partner in the Mercosur customs union. Itau's technical capacity is already sending nervous waves through Argentina's banking sector as local banks gear up for sophisticated competition.
Dennis finds the phenomenon interesting but believes it is still in its very early stages. "Way, way down the road you could see major regional groups beginning to form. So some banks may start to dominate the region,"
he says.
Berdeja agrees: "It's a little bit early to call it a trend." Whatever ambitions banks secretly harbour have probably been muted by the shock of Mexico's devaluation and the challenges posed by consolidation and problem loans. "Most banking systems still have too many problems at home to be looking outside for opportunities," she says.
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