BankinginBoliviawithRiotsontheStreets.doc

Banking in Bolivia with Riots on the StreetsBy Jaime Dunn De AvilaOn June 17 Fitch Ratings revised its Outlook rating for Bolivia from B- Stable to B- Negative. TheresaPaz, Fitch sovereign analyst for Bolivia says “the revised Outlook reflects concerns that recent social andpolitical turmoil in that third world country could jeopardize medium-term economic prospects”. Politicalturmoil and social unrest are nothing new in Bolivia. Widespread poverty, high unemployment, racialdiscrimination, corruption and the fatigue of the neo-liberal economic model implemented in 1985, arethe principal causes of continuous crises and instability since 1998.The Bolivian banking system is small compared to other Latin American countries, a reflection of the sizeand poverty of Bolivian economy. In the last few years, the banking sector formed by 13 banks, hassuffered five dramatic blows that caused capital flight, an increase in the levels of credit defaults and apersistent shrinkage on the level of outstanding loans. In December 1998, the banking sector had $4.2billion in loans and $3,5 billion in bank deposits. The first week of June 2005, those figures are $2.5billion (-40%) and $2,6 billion (-26%) respectively. Since 1998 over a billion in bank deposits have beenwithdrawn while credit defaults have increased nearly 250%, from 6.5% to 16.3%.A good portion of the reduction on outstanding loans has been the result of policies carried out byCitibank NA and Banco Santa Cruz (since 1998 owned by Banco Santander Central Hispano of Spain).Since the year 2000, Banco Santa Cruz has gone from being the largest bank in term of assets, to the fifthplace today. And at the end of 2004, Citibank NA reduced significantly its banking operations in Bolivia,shrinking its operations to a single branch. In the meantime external financing to locally owned banks hasshrunk from $917 million in 1998 to only $98 million today. Apart from Banco Santa Cruz, the threesmallest banks in Bolivia are foreign owned. This reflects the tough banking environment in Bolivia thatcauses foreign owned banks and subsidiaries to move their business elsewhere. At the same time, it showsthat having a large international presence maybe a weakness in times of crises, because foreign capitalmoves out of the country quickly, whereas locally owned banks have to endure the situation.Undoubtedly the Bolivian banking system has endured many blows recently thanks to the strict bankreform and regulation that began in the nineties, and the fact that the Bolivian banking system is made outmostly of local capital. These facts had a positive impact in preparing the banking system to confrontharsh social and political times. Since 1987, all banking regulation and control tasks were separated fromthe Central Bank of Bolivia (BCB) and trespassed to the Superintendence of Banks (SB). Although theBCB is on charge of issuing important norms applied to the banking system, the BCB is an autarkicinstitution and its main purpose is to maintain the monetary stability and the purchasing power of theboliviano, the local currency. The SB enforces all norms issued by the BCB.To ensure the independence of the BCB and the SB from direct government interference, the President ofthe BCB and all members of its Board of Directors are chosen by the President of Bolivia from a short listof candidates proposed by the Chamber of Deputies of the Bolivian Congress. While the Superintendentof Banks is chosen by the President from a short list proposed by the Senate.The BCB and the SB have been recognized internationally for having applied good measures of prudencethe last few years in order to preserve the health of the banking system under continuous stress. SinceMay 31 of 2005, a new norm for evaluation and scoring of credits was introduced, replacing the normestablished in 1999. Under this new norm, which also paves the road towards Basel II, the SB seeks tostrengthen the baking system even more and to stimulate the generation of new loans. The new normcreates eight categories for all loans, from “A” (normal) to “H” (lost). Under the new norm, clients mustnot only have good guarantees, but must also prove enough sources of income and must have an excellentpayment record. The new norm is not without cost, all banks have to invest about 10% of their equity onimplementing it.In the pipeline more banking regulation is in place: the Law of Corporate Governance, of Liquid Assets,Leasing and legislation on tributary matters aimed to protect and encourage more financial activity. Onthe other hand, newly signed Stand By credits with the International Monetary Funds come with eventougher banking norms that increase previsions and liquidity levels even more. In response, an analystsaid, “Bolivia is a country with the economy of a poor African nation, with a US rate of inflation and aSwiss banking regulation”. Others observe that strict norms are in fact the cause of the 40% reduction in outstanding loans since 1998, because under ever increasing requisites, less people and corporationsqualify for a credit. Meanwhile, loan sharking is booming.Looking at the development of the Bolivian banking, we can see that the boom started in 1995 peaked in1998. The rapid reduction of coca plantations under US pressures, the severe credit crunch to theproductive, and poverty exacerbated by declines in informal sector income, shrank the financial system.After 20 years of neo-liberal policies, widespread poverty and reform fatigue, people demand a change inthe economic model. As result, in the last five years, Bolivia has had five Presidents. In June 2002, inresponse to the slim election victory of neo-liberal President Gonzalo Snchez de Lozada with theshocking second place obtained by Evo Morales, $396 million or 14% of all bank deposits werewithdrawn. Morales is radical socialist “coca leaf” leader of the Movimiento al Socialismo (MAS), ashelter for coca-growers of the Chapare region, with demonstrated sympathy of Cubas Fidel Castro andVenezuelas Hugo Chavez. Afterward on February 2003, in response to Sanchez de Lozadas intention topioneer the first capital gain tax in Bolivian history, the social unrest, violent rioting and a police mutiny,caused $207 million or 8% of all bank deposits to be withdrawn. Later on October of 2003, after nearlythree weeks of political chaos and social unrest, Snchez de Lozada was forced out of the government,and $242 million or the equivalent of about 10% of all bank deposits were lost.The fourth crisis happened in the first three months of 2004, when due to the severe fiscal deficit of 9,0%of GDP, President Carlos Mesa proposed the creation of a “financial transaction tax” of 0,3% on alldebits and credits on bank deposits denominated in US dollars. Considering that close to 90% of alldeposits were denominated in US dollars, the impact in the banking system was large. Since theannouncement of the tax until it was implemented on April of 2004, close to $300 million or close to 12%of bank deposits were withdrawn seeking to avoid the tax. However, once the dust settled, bank depositsbegan to ascend until the most recent political crisis of June 2005, when Carlos Mesa resigned to thepresidency to allow a transitional government to call general elections at the end of 2005. During this lastcrisis that lasted nearly four weeks, $110 million or 5% of all bank deposits were withdrawn. Althoughthis crisis was more profound than the others, considering that even attempts to nationalize foreign oilcompanies assets were considered on the peoples agenda, the effects in the banking system were small.This because bank deposits grew about $103 million during the months of April and May when middle-year dividends paid by large foreign own companies were deposited, and because many bank customerswere able to deposit their funds after a short-lived panic caused by the appearance of counterfeited USdollars in the month of March, was finally over.But the dangers prying the banks are not only of political nature; there are also a mismatch between short-term deposits (14 months on average) and long-term loan maturities (up to 25 years). Moreover, close to88% of all bank deposits and 95% of all loans are denominated in US dollars, while most of the debtorshave incomes inbolivianos. This mismatch on currency and loan maturities is also a problem hard tosolve because of the high level of “dollarization” in the economy. “Dollarization” is a common term incountries that suffered hyperinflation in the past. It basically means that the US dollar is used on most ofmonetary transactions within the country replacing the local currency as an instrument of exchange andsavings. In Bolivia, dollarization has its origins in the lack of confidence of the public in theboliviano, asresult of the 20.000 % hyperinflation of the mid eighties, becoming the largest inflation on record in theworld during peacetime.Moodys Investors Service rates Caa1/Caa2 in foreign currency to the largest banks of Bolivia citing the“high level of dollarization”. The dollarization of bank loans is harmful and potencially catastrophic inBolivia because, as we said most of bank debtors have their income inbolivianoswhile they must payback their loans in US dollars. Considering that devaluation runs about 6% on average for the last fiveyears, on a 10% rate of interest on a credit you must tack on an additional 6% due to devaluation. Thatcertainly pressures all debtors increasing the levels of loan delinquencies, which have steadily risen inBolivia from 5.2% in 1997 to 21.5% in 2001, coming down to 13.7% in 2004. Another problem withdollarization is that the Central Bank can hardly play the role of lender of last resort for the banks since itdoes not issue US dollars and must always maintain high levels of international reserves. According tothe BCB, the high levels of dollarization of the economy, forces banks to have about twice the normalliquidity of banks in non-dollarized nations. In response, Bolivian authorities have introduced in 2001 theUnidad de Fomento a la Vivienda (UFV), an inflation-adjusted index that allows for loans and deposits inbolivianosto be adjusted for inflation. The success of the UFV has been moderate, but it is increasinglyused on the country, especially since some tax relief has been given to transactions in local currency. Under the described stressful scenario, the Bolivian banking system had to apply a severe cost reductionstrategy, restructure liabilities and implement measures of prudence to avoid liquidity problems. SinceDecember of 2000, administrative costs have been reduced 28% and costs of staff in 33%. At the end of1998 there were a total of 15 banks in Bolivia with 353 agencies and 6.808 employees nationwide. Nowthere are 13 banks, about 230 agencies and 4.000 workers. The high level of liquidity (liquid assets overdeposits) of the Bolivian banking system has been about 33% for the last five years. This liquidity ismostly invested in short-term government paper, repos and short-term bank deposits in the US. However,the high level of liquidity has affected profitability. On average, Return On Assets (ROA) has been0,12% and Return On Equity (ROE) 1,5% for the last five years.Although 2002 and 2003 have been the only profitable years for the banking system as a whole, Bolivianbanks have learned to do business with riots on the streets. Banks depend less on loans to generateincome and are more service oriented. Important investments in technology have been implemented, costcontrols and risk management have become a priority. Banco Nacional de Bolivia (BNB), fully owned byBolivian nationals headed by the Bedoya family, has emerged as the largest bank in the country with$623 million in assets and 16.77% of all bank loans. For 2004 BNB registered a profit of $2.7 million and$42 million in equity. In a recent interview, Antonio Valda, Deputy General Manager of BNB said thatthe profitability and solvency of BNB is due to a modern but prudential risk management, toadministrative efficiency, to the implementation of a policy to increase the operative income and a changein the way of doing things: some divisions of the bank concentrate in the loan related business, whileothers are dedicated to the non loan related commercial, international and service related businesses.“Under times of stress the trust of the depositors is the key to maintain the bank divorced of the socialproblems”, says Valda, and complements his thinking with a vote of confidence: “People trust BNB, weare the oldest bank (133 years) yet the most modern institution regarding technology in Bolivia. It takes alot of effort and time to be number one; it requires detailed planning and dynamic implementation and wehave done just that “.In the same interview, Alberto Valdez, Financial Manager of Banco Mercantil, the second bank ofBolivia in terms of assets ($546 million), says that their business has found stability because their clientsare “corporations and small and medium enterprises that adapt very rapidly to good and bad times”.Banco Mercantil is about 97% owned by Bolivian nationals and about 3% by a Panamanian interest. In2004, this bank had a profit of $5.4 million and $59 million in equity. Banco Mercantil has also been ableto diversify risk and obtain cheaper financing from international banks. Valdez also says that thereduction in administrative costs, innovation and investments in technology have been fruitful. “BancoMercantil puts first its solvency before profitability”, says Valdez referring to how banks prioritize highlevels of liquidity under the countrys circumstances.In spite of political and social unrest since the year 2000, Bolivias economy has improved lately due toworldwide growth and the governments success of controlling the fiscal deficit. Real GDP growth hasbeen 3.6% in 2004, up from 2.8% in 2003. In 2005, real GDP growth is expected to be at around 4.5%.High international commodity prices and increased export volumes have benefited the countrys externalaccounts, with export growth reaching 36% setting new records every year. This has resulted incontrolled currency devaluation with inflation of 3.2% for the year 2004. As result, the banking systemhas remained solvent. “We have a social and political crises, but not financial crises” is the official wordof the Bolivian Bank Association (ASOBAN), at the same time that warns that the challenges for a betterbanking system are still enormous. Certainly, the mismatch of currency and maturities is a ticking bombthat must be deactivated.Jaime Dunn De AvilaChief Executive OfficerNAFIBO Sociedad de Titularizacin S.A.La Paz-Bolivia_BOXThe high level of liquidity of the Bolivian banking system has dramatically lowered loan rates, especiallyin the mortgage market. In the year 2000 the average loan was about 13% per year in US dollars for a 12 year maturity, now is about 7,5% for a 15 year. The high levels of refinancing shown in the high levels ofprepayments and the need to maintain high levels of solvency have veered banks into looking forsecuritization of mortgage-backed securities as a way to accelerate profits.Nacional Financiera Boliviana (NAFIBO ST) is a Bolivian securitization agen