BANK SCANDALS ARE nothing new. From BCCI to Barings, financial institutions have been brought down in the wake of the discovery of holes in their accounts. Now you can add Baninter to the list.
In the case of the third-largest bank in the Dominican Republic, though, the effects were much worse than those of bank frauds elsewhere. The scale of deception was so big that it has devastated the entire economy, which has suffered a currency collapse, a dramatic widening of bond spreads, and a downgrade of its credit ratings.
The bank within a bank at Banco Intercontinental (Baninter) was uncovered in April, after its purchase by Banco del Progreso was agreed. Baninter had 14.6% of the banking system’s assets, while Progreso was the sixth-largest bank, with 7%. The deal never closed. Progreso’s due diligence uncovered what regulators and the bank’s auditor had missed for more than a decade: embezzlement and fraud that had siphoned off at least $2.1 billion, about 10% of GDP.
The central bank immediately stepped in to guarantee all deposits. As increasing numbers of clients started asking for their money back, however, it became clear that if they all received cash there would be nasty implications for the money supply. The central bank therefore started issuing certificates of deposit rather than cash, but the DR peso kept plummeting. Depositors were swapping pesos for dollars, and there was evidence of growing capital flight.
Analysts have been complaining for years about the republic’s weak institutions, and it is hard to get reliable financial data. There were soon rumours that the problems were not confined to Baninter. As Bear Stearns analyst Franco Uccelli said in a May research report, “that Baninter was able to engage in this kind of fraud and mismanagement for over a decade does not give comfort that it is an isolated event”.
Before long, the central bank was providing liquidity to another bank facing hefty outflows. It’s not clear whether Bancredito, the fifth-largest bank, was the unfortunate victim of a rumour-led bank run or had itself been hit by fraud. Either way, it was rapidly sold off at an undisclosed price to Banco Professional, part of an undoubtedly strong financial group called Grupo Leon Jimenes.
The largest banks are probably now relatively well capitalized. Some indication of which might be at risk can be gleaned from the interest rates they were paying on deposits before the Baninter crisis. “Baninter was by far the bank that was paying the highest interest rates,” according to Gustavo Lopez, a banking analyst at Fitch Ratings in New York. “We believe that Baninter was an isolated case among the medium-to-large banks,” he says. “We would not expect to see this happening to other institutions.”
But foreign banks that deal with the Dominican Republic are not taking chances. Credit lines have been slashed or eliminated, to the point where the turmoil is even hurting parts of the banking system in Miami.
The impact on the republic’s national accounts has been dramatic. GDP growth, nearly 4% in 2002, is likely to fall to 0.5% in 2003, according to Richard Francis, a sovereign analyst at Standard & Poor’s. In dollar terms, with the weakness of the peso, GDP is likely to drop to $18.2 billion from $22.6 billion, according to Bear Stearns. And with all the extra liquidity, the 12-month inflation rate in April was 18.3%, double the official target for 2003.
A disaster for the national debt But the real damage has been to the national debt. The Dominican economy has been one of the fastest-growing in the Americas for many years, and never really needed to borrow. Its $500 million debut bond issue came in September 2001, and was followed by a $600 million bond this January. Total public debt at the end of 2002 was just 21.9% of GDP, and interest payments accounted for just 6.5% of government revenues. But even though those numbers were small on an absolute level (countries with double-B credit ratings have an average of 60.6% debt-to-GDP and 18.3% interest-to-revenue ratios), they were rising quite fast. The boom years were coming to an end, and government spending wasn’t slowing in response. The Baninter crisis took those ratios through the roof. Debt-to-GDP almost doubled, to 41.7%, and interest-to-revenues more than trebled, to 21.5%. The republic found itself in desperate need of an IMF bailout just to pay the interest on the debt instruments being given by the central bank to Baninter depositors.
And while most of the general government deficit of about 9% of GDP this year is at the central bank, under the constitution any central bank deficit has to be taken on by central government at the end of each year. What’s more, the fiscal deficit, not including central bank obligations, is already estimated at 1.2% of GDP by JPMorgan, while Bear Stearns says that the central bank foresees a deficit of 1.9% to 2.2% of GDP this year. Both agree that the IMF is going to impose harsh fiscal medicine, forcing the republic to slash its deficit even as its economic cycle moves from boom to bust.
For the government, it is the worst time to be asked to cut public expenditure since there’s a general election next May. Already, the president has announced that he will neither raise taxes nor lay off public sector employees. But while the slowing economy could hurt the present administration at the polls, the Baninter scandal itself is unlikely to cause too much political damage. Baninter seems to have done a good job of tainting just about everybody in the country’s elite. No-one, in this situation, is eager to throw the first stone.
Baninter was owned and run by Ramon Baez Figueroa, whose grandfather, Buenaventura Baez, was president five times. Ramon always enjoyed luxury, but his extravagance increased after he got his own bank. His businesses were omnipresent in the republic, including four newspapers, three TV channels and 70 radio stations.
Virtually everybody in a position of importance in the republic had reason to be grateful to Baez. President Hipolito Mejia and his predecessor Leonel Fernandez received bullet-proofed cars and trips in Baez’s private jets. Many people, from the security forces to judges to the Catholic Church, received gifts from Baez. He had four yachts, four private aircraft, and four helicopters, dozens of boydguards, and homes in Vail, Colorado, and in southern Florida.
Baez was arrested in May, and some of his associates have also been held on fraud charges. But no-one in the government or the opposition has called for a wholesale crackdown on corruption.
When one analyst travelled to the Dominican Republic on an investor trip before the Baninter scandal broke, a US official there was surprised that no questions were being asked about the scale of graft. “We see corruption everywhere, at all levels,” the analyst was told, and there’s little indication much has changed post-Baninter.
Certainly the Baninter collapse and the consequent sharp deceleration of the Dominican economy puts its growth over the past 10 years or so in a different light. Once considered the architect of an economic dream, Leonel Fernandez now looks more like the man in charge of an out-of-control boom. For instance, says Bear Stearns’ Uccelli, “when the banking system is growing too fast, that comes at the expense of proper controls and regulations”.
Sonia Martin at JPMorgan is more upbeat. She expects growth as high as 2% this year, and says that “in terms of fundamentals, we do see the Dominican Republic as a pretty strong story in terms of growth”. She is optimistic about the effects of an IMF package and released a research report last month entitled Dominican Republic: Move to Overweight Ahead of Multilateral Assistance.
Lopez at Fitch takes a different view. He worries that “any of the banks may prove vulnerable to quick shifts in market confidence” and that the deposit outflows from Bancredito are a “further manifestation of the deterioration of the operating environment”.
Martin, on the other hand, says that the Bancredito buyout “is a positive development that should be an important first step in the consolidation of the crowded domestic banking sector”.
Optimistic developments There are some grounds for optimism, though, the recent sovereign downgrade by Standard & Poor’s to single-B status notwithstanding. International Finance Corporation, the World Bank affiliate that finances private-sector projects, recently injected $10 million of tier 2 capital into Banco BHD, the third-largest bank, as well as providing another $10 million towards loans to help the bank expand long-term lending to middle-market companies.
Enrique Iglesias, the Inter-American Development Bank president, has been spending time in Santo Domingo, and is likely to put pressure on the IMF to come up with a sizeable package speedily.
Possibly more important is the presence of IMF and US Treasury teams. The no-questions-asked bailout of Baninter, the rapid sale of Bancredito, and the forthcoming sell-off of Baninter’s assets (the rumoured buyer is Canada’s Scotiabank) all have the IMF’s fingerprints on them. There are few government employees qualified for crucial roles such as the supervision of the banking system. So the IMF’s technical assistance could be just as important as its cash.
The Dominican economy is used to growing fast, and its export sector is still booming. What’s more, with the peso weakening against the dollar and the dollar against the euro, tourism – which relies heavily on Europeans – has never looked healthier.
Now that the IMF looks set to impose discipline on the economy, there is hope for the Dominican Republic in the long term.
