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OPINION

Latin American banks: Where is the risk?

Asset quality is under threat across the region, but particularly in Peru.

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As inflation and interest rates rise across Latin America, pressure on the regional banks’ asset quality is rising in tandem. It is, therefore, worth scanning across the region to get a sense of the most likely source of potential bank risk.

Leaving Argentina aside – for obvious reasons – the greatest concern seems to be about Peru, both on a macro and micro level.

Peru is home to a unique set of risk drivers: the country has been in the throes of political volatility that is turning its traditional strength – fiscal discipline – on its head. After five presidents in five years, the most recent incumbent is taking the country in a new, leftward direction. The minister of finance is no longer being guided by fiscal discipline and an intent to encourage private-sector investment, neither in commodities – a traditional strength – nor to diversify the economic base of the country.

Lower credit demand

Instead, president Pedro Castillo, who has been in power since July, has thrown Peru’s ability to capitalize on surging copper prices into doubt. Copper is the metal set to benefit most from the world’s twin trends of decarbonization and electrification.

There are proposals to nationalize some of the mining industry and substantially increase taxes for the remaining private organizations. Broader interventionist policies – such as those that limit banks’ ability to set commercial interest rates – have also been introduced, despite the damning real-world case study of such regulations having played out in Argentina.

Credicorp has a weak starting position going into a period of deteriorating asset quality

The result has been lower credit demand – principally corporate, but also retail – which is hitting both bank-loan growth and the economy. In February, credit to companies slowed to 5.2% on an annual basis – a notable slowdown from 5.8% in January.

On a monthly basis, corporate credit grew by 0.8%, while retail loans fared better, up 1.5% in February compared with January. Standard & Poor’s – which has a negative CreditWatch on the country – reckons the country will grow GDP by 3% this year – not a terrible result but considering that the economy is going through a Covid snap-back, it’s a poor return.

Credicorp's risk cushion

This tough operating environment adds to the focus on Credicorp, Peru’s leading financial institution. Of the region’s large banking groups, Credicorp has a weak starting position going into a period of deteriorating asset quality.

With a CET ratio of 11.1%, the bank has a lower capital cushion than most of its regional peers. Indeed, a recent report by UBS BB highlights that Credicorp’s ‘risk cushion’ to protect against rising delinquencies in loan portfolios or losses in bank equity is toward the bottom of its range.

Expressed as a percent of equity, this cushion is just 10.2%. UBS BB does not think this is worth sounding the alarm over quite yet – and many of the bank’s more traditional ratios are still healthy – for example its non-performing loan (NPL) ratio is 202%.

However, given the tough macro outlook, it’s something to monitor. Other banks’ risk cushions provide more room for comfort: Santander has the lowest of the large Brazilian banks, with a ratio of 23.9%, and Bancolombia’s is 28.8%.