“Having a currency is just too expensive”
Rodríguez en route to low inflation
Panama: skyscrapers and secrecy
A glimpse up the deal pipelines
On a busy roundabout in Guatemala City stands an obelisk, a moderately impressive feat of 19th-century engineering. It is a symbol of independence at the heart of the city where Central America’s sovereignty was declared in 1821. At the foot of the monument there is a glass case with an inscription that reads: “This flame symbolizes our supreme aspiration of liberty and justice. Venerate it. Respect it. Never let it go out.” Inside the case there is a slightly rusty oil lamp – but no flame.
The assertive and optimistic mood of liberalism in which this country was born is long gone. Not only did the Federation of Central America hold together for only a handful of years but the social and economic freedoms its founding fathers fought for were soon forgotten. During the Cold War, in particular, military government, repression and civil war put paid to social freedom in much of the region.
| Central America’s largest banks by capital | |||||
| Country | Total capital $m | Capital/assets % | Total assets $m | ||
| 1 | Banco Agrícola Comercial | El Salvador | 128 | 6.7 | 1,899 |
| 2 | Banco Cuscatlán | El Salvador | 112 | 7.2 | 1,567 |
| 3 | Banco Nacional de Costa Rica | Costa Rica | 100 | 5.6 | 1,791 |
| 4 | Banco de Costa Rica | Costa Rica | 98 | 8.7 | 1,125 |
| 5 | Banco Salvadoreno | El Salvador | 92 | 9.6 | 955 |
| 6 | Banco de Comercio | El Salvador | 51 | 8.0 | 634 |
| 7 | Banco Fomento Agrop | El Salvador | 44 | 16.4 | 271 |
| 8 | Banex | Guatemala | 43 | 19.7 | 220 |
| 9 | Scotiabank | 40 |
7.8 |
507 |
|
| 10 | Banco de Desarollo | El Salvador | 40 | 7.0 | 566 |
| 11 | Banco de Occidente | Guatemala | 36 | 10.7 | 342 |
| 12 | Bancatlan | Honduras | 35 | 7.6 | 460 |
| 13 | Bancasa | El Salvador | 32 | 8.1 | 401 |
| 14 | Banco Industrial | Guatemala | 32 | 6.4 | 497 |
| 15 | Bancahsa | Honduras | 31 | 8.5 | 363 |
| 16 | Bancocci | Honduras | 29 | 11.1 | 260 |
| 17 | Citibank | 28 |
11.9 |
237 |
|
| 18 | Banpais | Honduras | 26 | 10.5 | 248 |
| 19 | Credito Agrícola de Cartago | Costa Rica | 25 | 5.0 | 500 |
| 20 | Banco del Agro | Guatemala | 25 | 7.2 | 342 |
| Excludes Panama; all data at December 1998 except Guatemalan banks March 1999; where possible data for majority owned subsidiaries have been included with parent | |||||
| Source: national bank regulators | |||||
But economic freedoms were discarded even more absolutely during these decades. Governments of both right and left decreed the abolition of the laws of economics and took much of the economy into state hands where it was for the most part ill-managed. Hopes that the economy of the region could leapfrog its way to prosperity through state management, protectionism and government-directed investment died in the Latin American debt crisis of the 1980s.
The 1990s were a time of cautious social reconciliation as armed men of all types lost their superpower backers abroad and were discredited at home. Trade tariffs were reduced, but progress on privatization and ending state monopolies was patchy. The region’s economies grew a little, but barely enough to bring them back to the level they enjoyed in the 1970s.
Then came two shocks: Hurricane Mitch, which visited biblical destruction on the heart of Central America; and the creeping crisis in emerging markets. Between them they brought a wave of realism to the region and, with it, a new sense of the urgent need for change. At first the region seemed to escape the effects of the crisis in Asia and then Russia. Some Guatemalan banks that had punted in emerging markets got their fingers burnt and a couple of Eurobond issues were postponed. But with little indirect foreign investment anyway and isolated banking systems, the problems seemed a long way away.
But this year, when Brazil was forced to devalue and much of Ecuador’s banking system collapsed, Central America has begun to feel fragile. The World Bank and the Inter-American Development Bank are pressing for the region to strengthen its banking systems and plenty of local politicians now see the urgency of the task.
But the biggest change this year is that the myth of monetary sovereignty has been exploded. The power of the shockwaves from Brazil’s devaluation are hard to underestimate. Now the leaders of every country in the region bar one are seriously considering abandoning their currencies in favour of the dollar.
The dollarization of Central America may well happen more quickly than anyone expects. And it will hasten the process of Central American economic integration, which is anyway reaching critical mass after years of slow-burn progress. A wave of banking mergers, many of them international, are soon likely to sweep the region. The banking quarters of downtown San José, Guatemala City and Tegucigalpa could soon be largely indistinguishable.
That process will go hand-in-hand with the restructuring and consolidation of corporate Central America. Just as the Salvadoran airline Taca has evolved from being a stodgy, state-owned national carrier into an efficient, truly regional airline and Central America’s first blue chip, so other regional stars may soon emerge in sectors such as retailing, construction, transport and insurance.
The big impact of Hurricane Mitch has been to hasten privatization. The two countries worst hit, Nicaragua and Honduras, face a clear choice: spend a generation rebuilding infrastructure and industry in the old way, or throw open the doors to foreign investment of a magnitude that only wholesale privatization can attract.
The result of all these changes should be a steady flow of deals – many of them small, at least initially – for investment banks. No investment bank (unless you include Citibank) yet has a permanent presence in the region. But the airports of San Salvador, San Pedro Sula, Belize City and Managua could soon become much more familiar to many investment bankers.
Dreams could come true
And as international investors worldwide begin to rediscover their appetite for Latin American risk, Central America could yet fulfil the dreams of its creators. If it embraces these new ideas the region has the potential to grow strongly and attract far more investment than it ever did in the past. That would mean a rediscovery of the self-confidence and ambition that for so many of the years since independence have seemed laughable. The last years of the decade may come to mark the point at which Central America – which if it was unified would be Latin America’s third-largest country by population – begins to emerge for the first time as a cohesive and significant economic entity.
The big idea that is sweeping Central America this year is dollarization. This is not a new idea: but it is one whose time has come. Governments in the region have long known how fragile their monetary independence is. In 1994 El Salvador was on the point of jettisoning its currency in favour of the dollar, having calculated that by using its foreign-currency reserves to buy every dollar in circulation it could banish for ever the prospect of devaluation and see interest rates only a couple of percentage points above those in the US.
Then came Mexico’s tequila crisis. The multilateral agencies encouraged El Salvador’s government to back off from dollarization. Instead, the country has pursued a de facto currency-board policy ever since. The central bank is banned from lending to the government; the exchange rate has been kept at a constant ESc8.75 to the dollar; and, thanks in part to a steady flow of remittances from Salvadoran expatriates in the US, the country has maintained strong reserves of foreign currency. At the end of 1998 they stood at $1.6 billion and the amount of cash in circulation and sight deposits at banks was just under $1 billion.
Brazil’s forced devaluation dealt a body blow to the idea that Latin American countries could manage their currencies through a process of gradual, controlled devaluation. Argentina’s president, Carlos Menem, was quick to point out that Argentina’s strict currency-board system was much stronger than Brazil’s monetary system and hinted that the country could go further – by simply swapping every peso in circulation for the dollar that backs it in reserves. Mexican politicians have also pondered swapping their peso for the dollar: through the North American Free Trade Association, Mexico’s economy is more closely tied to the US than any other in Latin America.
And it is no coincidence that these thoughts came just as 11 European countries were giving up monetary sovereignty to the European Central Bank in Frankfurt. If Europeans can let go of the franc and the Deutschmark, say many Latin Americans, why should we be so attached to currencies that over the years have been frequently redenominated, rehashed and devalued?
But the big Latin American countries, Mexico especially, face a problem. Unilateral dollarization would be politically difficult to institute. National pride would demand some kind of treaty of currency union, something it is difficult to imagine attracting a high priority in Washington. Central America entertains no such illusions. And the region has a long-standing model of successful dollarization. Panama has used the dollar since its creation in 1903 and not only do Panamanians pay much lower interest rates than their Central American neighbours, they can also get access to much longer maturities. The country regularly has Latin America’s lowest rate of inflation.
“People complain that dollarization precludes devaluation,” says Manuel Enrique Hinds, finance minister of El Salvador until May 31, and Central America’s foremost advocate of dollarization. “Well for me that’s the great thing about it. Every devaluation wipes out savings. A society cannot work properly if it does not have a strong currency which can be trusted.”
El Salvador is the clear front-runner to be the first to adopt the dollar completely. Its population has learnt to appreciate the benefits of currency stability, it has just elected a new free-market government for a five-year term and the country has a strong recent track record on adopting radical economic changes such as large-scale privatization and pension reform. The strength of El Salvador’s public finances was reflected in last month’s upgrade of the sovereign to BB+ by Standard & Poor’s.
Belize is another strong candidate for dollarization. Like El Salvador, it has had an effective system of convertibility for many years. The Belize dollar has been tied at two-to-one to the US dollar since 1976.
Guatemala, Central America’s biggest economy in absolute terms, is also leaning towards dollarization, but has a lot of work to do in order to get there. “We think that Guatemala is approaching the scenario of a currency board in perhaps two years’ time,” says Edin Velásquez, governor of the Guatemalan central bank. “We are eliminating all sources of issuance of money from the central bank. We don’t give any credit to the government. So we are approaching a kind of currency board. We have been talking about the possibility of dollarization. But I don’t think we can go that far in the short term.”
Forex reserves need a boost
But Guatemala’s level of foreign exchange reserves is low – only 9% of money in circulation according to Velásquez. The central bank has little independence from the government. Last year, for example, it was forced to run down its reserves to pump liquidity into the banking sector following the collapse of two coffee-export companies. “We need to accumulate more foreign-exchange reserves,” says Velásquez. “And we can do that over the following months. If we keep monetary policy under control we won’t need to intervene in the foreign-exchange market using our current reserves. We can build up reserves gradually to a point where they match currency issuance.”
For many years Honduras had one of Central America’s best records on monetary stability. Inflation was kept low and the lempira was pegged to the dollar at two-to-one. But since 1990 the currency has fallen to La13.8 to the dollar and inflation has risen to double figures. Nevertheless, a relatively good current-account balance has allowed foreign reserves to grow strongly in the past three years. They now exceed the monetary base, making Honduras another good candidate for dollarization.
Nicaragua suffered hyperinflation for much of the 1980s. As a result there is a strong popular appreciation of the benefits of a stable currency. The country’s government and business leaders – many of whom were exiled to Miami during the government of the Sandinista National Liberation Front – have strong links with the US and many would have no qualms about dumping the córdoba. The conservative governments that have been in power since 1990 have made steady progress on achieving monetary stability and building up a reasonable level of forex reserves.
Few would put Costa Rica high on their list of Latin American countries likely to dollarize. It has learnt to live with entrenched inflation of some 12% a year, with which it finances its fiscal deficit. Public-sector workers form a strong lobby and there is widespread public support for the idea that the state should provide a wide range of public services – something it does with reasonable efficiency. The result is that no government has yet managed to get a grip on public finances. The currency, the colón, is devalued at a rate calculated in line with inflation. “It’s almost a fixed exchange rate,” explains José Rafael Brenes, manager of the central bank. “The system has been in place since 1987 so we have a lot of experience of maintaining this stability. I can’t see any external shock affecting the currency in the near future.”
But Costa Rica’s president, Miguel Angel Rodríguez, seems a convert to the idea at least of a currency board. He believes that after having reduced inflation to below 5%, the country should link its currency to the dollar. He doesn’t rule out dispensing with the colón altogether at a later stage, but his preference seems to be for a currency board (see interview on page 194).
The gut preference of many Central Americans is for a currency board rather than outright dollarization. But the important difference between convertibility and full dollarization is the higher interest rate that local borrowers would have to pay under a currency board to compensate for investors’ lingering doubts about the permanence of the system. If the small, highly dollarized economies of Central America adopt a currency-board policy they might soon find the attractions of full dollarization irresistible.
Many Central Americans’ biggest fear about dollarization is that its generally weak banking systems would be destroyed. With a national currency – even under a currency board – local banks enjoy an advantage in being able to take deposits in local currency. With dollarization it becomes almost as easy for individuals and companies to deposit their savings in New York, Miami or Panama as with a local bank. “Dollarization would bring intense competition to the banking sector,” says Rafael Barraza, vice-president of El Salvador’s central bank, “a currency board less so.”
But Hinds, along with officials of the banking regulator in El Salvador, has pointed out that dollarization should strengthen the banking system, since lower interest rates will increase the quality of the banks’ assets. “There would be a one-off, permanent bonus for the banks, because the quality of their loan portfolios would improve immediately as the rate of interest fell by about 7.5 percentage points.”
Some bankers in the region agree. “I am in favour of dollarization,” says Rafael Viejo, president of one of Guatemala’s largest banks, Banex. “It would be a much simpler, more transparent system. It is true that if the central bank required of us the same reserves as it does now but in dollars that could cause us problems in competing for deposits with banks abroad. But the reason we have high reserve requirements is not just liquidity. They are there for monetary policy, which would no longer exist. In a dollarized system, reserve requirements could fall to a level of, say, 10%, where we would be competitive.”
For the most part, Central America’s banking systems are isolated and fragmented, having grown up under protectionism of one sort or another. El Salvador has the region’s strongest bank sector. Most of the country’s banks spent a decade in state hands. All the big banks were nationalized at the beginning of the 1980s; then, between 1990 and 1992, there was a corresponding wholesale privatization. “We lost out in two ways through this period of state ownership,” says Claudio de Rosa, executive director of Abansa, the country’s banking association. “Not only did we lose the skills of assessing credit because loans were allocated according to government decree. But also this was a period of rapid technological change in banking internationally. The skills of those bankers who did have experience of commercial lending were out of date. So when we privatized the banks we were really starting from scratch.”
But El Salvador’s bankers have quickly caught up and the biggest banks are widely acknowledged to be among Central America’s best. Two of them, Banco Agrícola Comercial and Banco Cuscatlán, each account for just over 20% of the system’s assets. The smaller banks are finding life increasingly difficult. One second-tier bank, Credisa, failed in December. Several others are embarking on, or considering, mergers. Since the end of last year, for example, Banco de Comercio has been in the process of merging with Banco Atlacatl, a smaller rival.
Credit to the private sector in El Salvador has grown by 17% a year on average for the past three years. Interest rates have fallen along with inflation in recent years, and the spread between interest rates on deposits and those on loans are low by Latin American standards, at between 4% and 5%. The quality of Salvadoran bank loans is generally good. Barraza of the central bank points out that non-performing loans account for only 5% of assets.
Overbanked Guatemala
By contrast with El Salvador, Guatemala has a weak and highly fragmented banking sector. The country is overbanked, with some 35 banks and finance companies serving what Ray Pucini, vice-president of Banco de Occidente, calculates to be a bankable population of only 100,000 households that are subject to credit.
Most of Guatemala’s banks are undercapitalized. The regulatory system does not force banks to consolidate the operations of subsidiaries on their balance sheets or oblige them to make loan-loss provisions. So the system could hide much risky or uneconomical lending.
| Honduras at a glance | |||
| Population: | 5.6 million | ||
| Currency: | lempira | ||
| GDP: | $5.2 billion | ||
| GDP per capita: | $930 | ||
| Total banking sector assets: | $3.2 billion | ||
| Total banking sector capital: | $275 million | ||
| Sovereign foreign currency rating: | – | ||
| 1996 | 1997 | 1998 | |
| GDP growth (% year-on-year): | 3.1 | 5.2 | 3.1 |
| Inflation (% year-on-year): | 29.5 | 23.8 | 13.7 |
| Currency units to $: | 12.9 | 13.1 | 13.8 |
| Foreign currency reserves ($m): | 211 | 491 | 660 |
| Money in circulation (M1 $m): | 442 | 581 | 620 |
| Source: Banco Central de Honduras | |||
Honduras’s banks are also undercapitalized for the most part. However the market is more concentrated than that in Guatemala, with six big banks accounting for 60% of assets. As in other Latin American countries, the average spread between rates on deposits and loans is high, at just over 10% according to Latin American Banking Federation.
Nicaragua’s banking system is even more feeble than that of Guatemala. At under 5%, the average ratio of capital to assets is low even by Central American standards. The total capital of the banking system stands at only $81 million and no bank has capital of more than $10 million.
There has been a big expansion in credit in recent years as the economy has staged a recovery from years of recession and stagnation in the 1980s and early 1990s. The value of deposits in the system has risen from $418 million at today’s exchange rate in 1995 to $1.2 billion in 1998.
For the most part the banks are inefficiently run. The sector’s average spread between rates on assets and liabilities is almost 17%. But the quality of the banks may soon be improved by foreign investment and already some foreigners, such as El Salvador’s Banco Agrícola Comercial, have bought stakes in local banks.
Costa Rica has a fairly large volume of banking assets in relation to the size of its population. But the system is weaker than it appears. The presence of three big state-owned banks, which account for more than 70% of the system, has stunted the development of a strong and dynamic banking sector. Banco de Costa Rica is the best capitalized and perhaps the best run of the three state-owned banks, and Banco Nacional de Costa Rica, which has expanded quickly in recent years, is the biggest bank by assets in Central America (excluding Panama). Banco Crédito Agrícola de Cartago is the third of the trio. There is also a fourth state-owned bank, Banco Internacional de Costa Rica (Bicsa), which is smaller and focuses on export finance. The banks have a very large market share but make a miserable return on equity of less than 2%. And as one banker who works for a privately owned bank points out: “It wouldn’t take much to do well when you enjoy the public subsidies they do.”
These subsidies do not come in the form of direct assistance from the government. Rather, private banks have to deposit 17% of their assets with the state-owned banks, in addition to the legal reserve they have to place with the central bank. These funds are supposed to be used to fund smaller companies that would otherwise have difficulty raising finance. In addition, state-owned companies are forced to use the public-sector banks for many of their services and enjoy a blanket government guarantee, which dulls their sensitivity towards riskier forms of lending. A banker in the private sector calculates the cost difference between the state-owned banks and private institutions at 500 basis points. But a director of one of the state-owned banks points out that they do not enjoy the same freedoms as the private-sector banks. They are forced to buy equipment through government channels, which can increase costs and allows them less flexibility. Earlier this year howls of indignation from the state-owned banks greeted the government’s imposition of restrictions on their lending growth – a move designed to limit monetary expansion.
Unprepared for crisis
Most officials, even of the present pro-reform government in Costa Rica, believe that state ownership of much of the banking sector is not a pressing problem. However these undercapitalized, bureaucratic institutions are ill-prepared for any future crisis. They are particularly vulnerable to a deterioration in asset quality. One close observer calculates that 70% of the banking sector’s lending is denominated in dollars; that would leave some clients hard pressed to make repayments in the event of any devaluation beyond the index-linked strategy pursued by the central bank.
Banking throughout the region – excluding Panama – shares some characteristics. By world standards all the banks are small. Almost all are funded largely by local deposits, rather than in the capital markets. The shortness of maturities is a headache for borrowers throughout the region. Very few banks in the region have significant access to any long-term capital sources. Several development banks, including the Central American Bank for Economic Integration, provide longer-term credit to the stronger banks. Guatemala’s Banco de Occidente recently secured a credit line of this type.
In 1998 El Salvador’s Banco Cuscatlán found an innovative way of tapping international capital by issuing a $50 million five-year bond securitized by remittances sent back to El Salvador from workers in the US through the bank. The bank also has other sources of long-term funding, including a $25 million line of credit from the IFC. “This is the first time the IFC has allowed its funds to be placed directly by a bank anywhere in Central America,” says the bank’s president, Mauricio Samayoa.
The absence of any significant international funding meant that Central America’s banks saw few direct effects of the emerging-markets crisis. What damage there was has been mostly on the other side of the balance sheet. In Guatemala, banks faced a surplus of liquidity in 1996 and some chose to invest in higher-yielding securities including emerging-markets paper. One bank even bought Russian GKOs.
A largely open market
For many years Central American governments protected their national banks through laws preventing foreign involvement in the market and outside ownership of local institutions. Now, however, the market is largely open. The only remaining restriction in most countries is that foreign banks have to be registered and capitalized locally: they cannot be run using the balance sheet of the parent company.
But there is no legal restriction on buying a privately owned bank in any Central American country. The biggest brake on foreign investment in the local banking market is lack of foreign appetite. The two Spanish banks, Santander and Banco Bilbao Vizcaya, which have high-profile Latin American strategies, are notable by their absence from Central America. The biggest foreign banks include Citibank, which has a strong presence in El Salvador and Guatemala, and Lloyds, which is active in Guatemala and Honduras.
Canada’s Scotiabank is one of the strongest foreign players in Central America and the Caribbean. The bank had been in Jamaica, other Caribbean islands and Panama for many years and decided Latin America, rather than eastern Europe, should therefore be the focus of the emerging-market strategy it adopted at the beginning of the 1990s. “Initially we made some mistakes,” says Alberto Tarabotto, general manager of Scotiabank de Costa Rica. “We bought minority stakes which did not give us the control we required to turn the banks round.”
In Costa Rica, Scotiabank bought Banco Mercantil just over three years ago. “We found it had a lot of problems,” says Tarabotto. “The systems were a mess; the software was all pirated. Of a staff of 200, I fired 100 and recruited 70 more. Now we are taking on another 70. We have a team dedicated to corporate business and now we are expanding in retail.” Scotiabank bought a Salvadoran bank, Ahorromet, just over a year ago and is now looking for opportunities in other Central American countries.
The region has also received some attention from banks in other parts of Latin America. Chile’s Banco de Desarollo bought El Salvador’s Banco Capital in 1997. Mexican banks were showing a strong interest in moving into Guatemala and beyond until their own financial crisis in 1994. Their problems provoked some glee among Guatemalan bankers, who regard their larger northern neighbour with some suspicion.
Intra-regional investment
But increasingly, investment in Central America’s banks is being carried out by other institutions from the region. For the past few months Panama’s Banco del Istmo has been attempting to buy Banex, a move resisted by that bank’s Costa Rican managers. Banco Agrícola Comercial, El Salvador’s largest bank, recently acquired majority stakes in the Honduran bank Banco de la Producción (Banpro) and a 50% stake in Nicaragua’s Banco Caley Dagnall.
Banco Cuscatlán, the other big Salvadoran bank along with Agrícola, is also pursuing a regional strategy. “Since the financial market of El Salvador has reached a certain level of maturity, and given that our main competitor has a similar market share to ours, growth within the country is going to be very difficult,” says Samayoa, the bank’s president. “El Salvador has the most developed financial system in Central America and that gives us a certain competitive advantage in respect of the other markets.”
Cuscatlán’s first targets are the two other big economies of Central America, Guatemala and Costa Rica. The bank has taken stakes in a bank in each of these countries. In 1998 it raised its stake in Costa Rica’s Cofisa to 51% and has a majority share in Guatemala’s Centrica, which it converted into a full bank last year.
From next year Cuscatlán will adopt a common identity for the bank throughout the region and will soon begin to look for buying opportunities in Honduras and Nicaragua. “At the end of the day what we want to do is to increase the value of the brand and so increase the value of the bank,” says Samayoa. “We think we can best do that serving the five countries in the region.”
A foreign banker who has worked for a number of years in the region believes that Cuscatlán, del Istmo and a few other Central American banks are positioning themselves as regional players with the specific aim of making themselves more attractive takeover targets for international banks.
Samayoa does not seem hostile to the idea of Cuscatlán attracting bids. “There is always the possibility of linking up with a strategic investor,” he says. “We have nothing concrete lined up. But we are always open to considering any possibility that arises.”
Guatemala’s Banex – unrelated to the Costa Rican bank of the same name – is another bank that hopes to become a regional player. It opened a branch in El Salvador recently and would have expanded further last year had it not been forced to divert capital to coping with the collapse of two customers and to dealing with a surge in liquidity issued by Guatemala’s monetary authorities. “We have a 10-year plan to become a regional player in Central America and south-east Mexico, taking advantage of our geographic position at the southern border of Nafta,” says Banex president Viejo.
And there are other potential regional players in niche markets. Promérica, a retail-focused bank that began life as a credit-card issuer, has operations in El Salvador, Honduras and Costa Rica. By its own calculations it is Central America’s largest bank. In mid-1998 it bought Bancorp, a smallish Salvadoran bank to add to its operations in that country.
A strengthening of regulation
New laws to strengthen the region’s banking sector should hasten the process of consolidation. Partly in response to pressure from international agencies, several Central American governments are in the process of introducing new banking laws. There are three main elements to these reforms. First, bank capital requirements are being raised. Second, supervision is being beefed up through tougher disclosure requirements and by giving stronger powers to regulators. In all countries of the region, supervisory agencies with independence from the government and central bank have been set up or strengthened over recent years. Third, lawmakers are trying to crack down on some of the sector’s shadier practices, such as lending to related companies and hiding dud loans in non-consolidated subsidiaries.
In Costa Rica financial groups are being forced to submit their consolidated accounts to the regulator this year. Most of the banks operate offshore subsidiaries so that Costa Ricans can hold their funds out of the reach of the tax authorities. Consolidating these accounts could prove expensive in capital terms. One banker reckons that the offshore banking assets of Costa Rican banks are of a similar size to the onshore banking sector.
In El Salvador a new banking law was due to be passed by the beginning of this month. Minimum capital will be raised over a period of time, probably to ESc100 million ($11 million) and 10% of assets. The new law also introduces a deposit guarantee fund. Guatemala’s new banking law, which would have raised capital requirements to Q100 million ($15 million) and forced financial groups to present consolidated accounts, appears stuck in parliament, where it will most likely stay until a new government is elected early next year. However, most bankers believe reforms will happen in Guatemala before too long.
In Nicaragua a set of new prudential standards were issued in 1998, designed to raise capital ratios, tighten definitions of non-performing loans and reduce lending to related companies. In addition, the Banco Nacional de Desarollo, a defunct state development bank, was wound up last year. New rules on capital adequacy will be introduced over time. From July 2000, according to the central bank, the country’s banks will have to have capital equivalent to 10% of their assets, a level few of them are close to at present.
| Guatemala at a glance | |||
| Population: | 11.1 million | ||
| Currency: | quetzal | ||
| GDP: | $13.5 billion | ||
| GDP per capita: | $1,216 | ||
| Total banking sector assets: | $5.1 billion | ||
| Total banking sector capital: | $439 million | ||
| Outstanding government debt: | $3 billion | ||
| Sovereign foreign currency rating: | Ba2 | ||
| Foreign currency reserves: | $111 million | ||
| Money in circulation (M2): | $4.4 billion | ||
| 1996 | 1997 | 1998 | |
| GDP growth (% year-on-year): | 3.0 | 4.3 | 4.7 |
| Inflation (% year-on-year): | 10.4 | 7.1 | 7.5 |
| Currency units to $: | 6.0 | 6.2 | 6.8 |
| Sources: Banco de Guatemala, Proguat | |||
The new capital requirements could in themselves force some banks, especially in Guatemala, to increase their capital through mergers. But the true effects of the reform process will be more subtle. Higher capital requirements, bigger loan-loss provisions and disclosure of complete group accounts will make banking less profitable for many smaller banks. “Many banks here are offshoots of industrial companies,” says a foreign banker in Guatemala. “They provide funds for the group and are often a source of pride to their owners. And at the moment they require so little capital that the return on capital is great. So why would you sell?”
When tougher capital requirements stop banking being a profitable activity for Central America’s multitude of tiny banks, the slow trickle of consolidation could become a wave. Within five years the region’s banking sector is likely to be much more unified and may consist mainly of regional financial groups and international banks. Only a handful of national banks of any size – perhaps the Costa Rican state-owned banks – are likely to hold out.
The laws should favour the banks that are better capitalized already. Guatemala’s Banex has one of the region’s highest capital adequacy ratios at nearly 20%. And its president, Rafael Viejo, points out that unlike many rivals, the bank already includes the activities of all its subsidiaries on its balance sheet. Its high level of capital proved useful last year: Banex was one of the banks hardest hit by the collapse of two companies that specialized in supply finance to the coffee sector.
Painfully slow privatization
Two other areas of financial reform appear to have stagnated. Privatization of state-owned banks is not an issue in most of the region where the majority of banks are already in private hands. Costa Rica’s state-dominated banking system is looking ever more anachronistic, but the pace of privatization in this sector – and in others – is painfully slow. One bank, Bicsa, is for sale. But one private-sector banker believes the state will have trouble finding a buyer for it. “The jewel in its crown is a US banking licence,” says the banker. “And the government would like buyers to assume that this comes as part of the package. But the US authorities don’t like banking licences to be passed around. Any buyer would probably find that it has to reapply for a US banking licence in its own right.”
Perhaps as a result of its inability to get privatization bills through parliament, the Costa Rican government is emphasizing the need to liberalize the economy and end monopolies rather than sell state assets. So private banks were given the right to operate current accounts for the first time in 1996 and these institutions have grown rapidly in recent years. The government hopes to put state-owned banks and private banks on an equal footing.
“The philosophy,” explains Ricardo Monge, director of the investment-climate improvement programme at the Costa Rican Coalition for Investment Development, “is to create a level playing field and a free market without necessarily changing ownership.”
Privatization of utilities such as telecoms and energy has proceeded apace in much of the region – though not in Costa Rica – but only El Salvador has embarked on pension reform. The new system was based largely on the successful Chilean model. From early 1998 Salvadorans were allowed to move their pensions from the state system to private asset managers. “The reform was accepted enthusiastically,” says finance minister Hinds. “Within one year, and largely within four months, more than 600,000 people migrated from one system to the other voluntarily.” The streets of San Salvador are now crowded with hoardings for private pensions provided by firms such as AFP, Provida Citibank and BBV. The new pension funds have collected more than $900 million in assets.
In most of Central America, the first priority of privatization programmes has been to bring in strategic investors with know-how to such industries as energy and telecoms. Raising money for the government is, of course, a useful side benefit. Using privatization as a means of developing a deeper local equity market has come a distant third on the list. But in Guatemala the government, having sold 84% of its most profitable power company Empresa Eléctrica to a strategic investor (Spain’s Iberdrola) for more than $500 million, is planning to sell the remaining stake on the stock market as soon as conditions are favourable. The specific aim is to nurture the growth of a local equity market which, as one government official puts it, is currently “science fiction”.
No Central American country has a well-developed capital market. Government debt is actively traded in countries with a large public borrowing requirement, such as Costa Rica and El Salvador, but few debt securities are raised by the private sector. In Costa Rica government debt accounts for as much as 99% of volume.
Stock markets in Central America are dominated by debt instruments of very short maturities. Reportes, a kind of repo, account for 80% of volume on the El Salvador stock exchange, mostly at seven days. Instruments with maturities of 30 days or less account for 40% of volume on the Costa Rican exchange.
Belize at a glance Population: 238,000 Currency: Belize dollar GDP: $690 million GDP per capita: $2,900 Outstanding government debt: $ billion Sovereign foreign currency rating: Ba2 Throughout the region equity volumes are derisory. Francisco Novoa, financial manager of the El Salvador stock exchange, has attempted to create an equity index of shares that have a specified minimal level of liquidity. He found that only four stocks met his criteria. Of the 20 companies listed in Costa Rica, only eight have any significant trading activity.
Disclosure requirements form perhaps the biggest barrier to the development of equity markets in Central America. Company owners fear, with justification, that they will be the target of extortion and kidnapping if they make details of their wealth public. For this reason few private companies in Guatemala and El Salvador have ventured onto the stock market. In Costa Rica, where crime rates are lower, the state’s stranglehold on the economy is the big limiting factor on equities.
El Salvador’s entire banking system was sold in the early 1990s through a series of public auctions, but this did not take place through the stock exchange. Most of the banks have a stock-market listing – this accounts for the Salvadoran market’s relatively high market capitalization of $2 billion – and according to Novoa these stocks are among the most traded. But volumes are thin. One banker claims that bank shares are usually traded over the counter with brokers used to source stocks only occasionally.
And El Salvador’s securities regulator appears to be doing its best to strangle what little capital-markets activity there is in the country. The Superintendencia de Valores is looking for ways to squeeze the reportes sector of the market, supposedly to stimulate longer-term funding. It has also introduced a directive that all shares listed on the exchange must have a credit rating – regardless of whether these companies have outstanding credit or not. The exchange is now lobbying to have this bizarre regulation removed.
Given their miserly volumes, it makes a lot of sense for Central America’s stock exchanges to pool their resources. Roberto Venegas, general manager of the Costa Rica bourse, believes this is the way forward. He says he has put out feelers about establishing a regional exchange to his counterparts in other countries but has received little feedback.
Novoa at the El Salvador exchange believes that talk of integration is premature. “It is too difficult from a technical point of view to introduce a common exchange while each country has a different currency,” he says. “Once we have created a common Central American currency, then we should start to think about unifying our exchanges.”
Venegas believes that given the Costa Rican exchange’s greater volumes (it accounts for 50% of the total Central American volume according to Venegas, although this is partly a function of Costa Rica’s greater public indebtedness), San José is the natural centre for a Central American stock market. A new regulatory environment in Costa Rica allows foreign securities to have a parallel listing there. Panama’s Banco del Istmo and El Salvador’s Banco Cuscatlán both have their shares listed on the Costa Rican exchange (in addition to their home stock markets).
Venegas thinks that integration will come eventually: “I can visualize a Central American market. But it may take the form of a single clearing mechanism with a physical location in each country”
Like so many aspects of Central American integration, stock market unification has become bogged down in the politics of geography. Thirty years ago the region had a functioning common market. Then the system collapsed amid war and recriminations over tariff levels. But the liberalization of Central America’s economy is leading to much greater commercial integration than the enthusiasts of the 1960s could ever hope to achieve by negotiation alone.
Tariffs have fallen throughout the region as countries have dropped trade barriers unilaterally. Trade within Central America is higher than at any time and it has become easier for multinationals – both homegrown and from outside the area – to treat Central America as a single market.
This has happened first in aviation. Only 10 years ago it was often easier to travel from one Central American capital to another by changing in Miami than to fly directly. Now flying within the region is cheap and hassle-free. The former Salvadoran state airline Taca has bought up the local carriers of most of the region and provides an efficient service on a fleet of new aircraft.
The same thing is beginning to happen in banking and other industries. And if Taca, Banco Cuscatlán or any other of the region’s emerging blue chips choose to sell out to US or European companies, the benefits of integration to Central Americans should be no less.
With the shock waves of Hurricane Mitch and the emerging markets crisis still reverberating, the region may for the first time be ready to accept that possibility.
