Throwing the Bathwater, but Saving the Baby

DISASTROUS CRISIS PROMPTS IDEOLOGICAL RETHINK

The Ecuadorean banking sector saw its bleakest period in 1998-1999, as the nation reeled from a devastating economic crisis, attributed, in fact, to the collapse of the banking system. That crisis would cost Ecuador $8 billion. Nearly half of the then 40 existing banks went to the wall, as the currency and public financing faced a meltdown. In the wake of the global financial crisis, local banks primarily suffered in trade business as credit lines from Correspondent Banks (Bancos Corresponsales) declined. In January 2000, the specter of hyperinflation prompted then President Jamil Mahuad to declare a state of emergency and adopt the US dollar as legal tender to replace the sucre.

Since then, the banking landscape has changed dramatically. In August 2012, then President of the Central Bank of Ecuador (ECB) Pedro Delgado stressed the need to boost domestic liquidity. In pursuit of this liquidity, the ECB raised the obligatory rate at which private banks must keep their assets and investments in Ecuador from 45% to 60%. The government has built up a liquidity fund to safeguard against repeat banking crises actually funded by taxing the banks, which, as of February 2013, stood at $1.2 billion dollars. Additionally, the ECB has ordered private banks to increase its contributions to Ecuador’s liquidity fund from 3% to 5% until September of 2013, and 1% annually up to 10%. The fund safeguards Ecuador’s financial system, in lieu of the ECB, which hasn’t done so since the 1998-1999 crisis.

RADICAL STEPS WITH TANGIBLE RESULTS…

The ECB was defined by the Law of the Monetary System of 1961. Formerly independent of the government, post-crisis the ECB was controversially subsumed within the executive branch’s economic team, and bolstered by a new Economic Planning Ministry. This was to ensure that it functioned in step with overall government policy on economic development. The Correa administration has also tasked the ECB with regulating interest rates to enable lending, spur economic growth, and reduce unemployment. Average real (inflation-adjusted) lending rates have since fallen, from a high of 8.28% in April 2007 to 3.85% today. Unemployment, meanwhile, plummeted from its historic high of 12.05% registered in April of 2004 to a 25-year low of 4.63% in September of 2012.

Correa’s program also levied a tax on capital leaving the country; a move recognized as improving the transparency of the financial system while swelling government revenue. Meanwhile, new legislation introduced by the Superintendency of Banks prevented banks from charging for various services such as card renewal. A provision in the 2008 Constitution barred financial entities or groups, along with their legal representatives, board members, and shareholders from media ownership. A subsequent referendum vote on constitutional amendment in 2011 squared up to two key sectors at once by banning private financial institutions and media companies from owning stakes in any company outside their respective industries. For the banks, this included their stakes in insurance and brokerage companies.

In December 2012, the government’s tax on so-called excessive bank net profits was passed, redirecting 3% of banks’ taxable income, again to get the private sector to shoulder the weight of social programs. In January 2013, the law went into effect to finance a 43% increase of the human-development bond, which since January 2013 has provided a cash payment of $50 a month to roughly 1.9 million underprivileged citizens. The president’s financial reforms have substantially swelled the government’s coffers from 27% of GDP in 2006 to more than 40% in 2012. This has enabled both expansionary fiscal policy and the marked rise in social spending that Correa had pledged pre-election. The ECB has also worked to reduce the number of unbanked citizens aiming particularly at 200,000 citizens in remote rural areas. The target is for an excess of 2.8 million new financial transactions by 2016.

…LEAVING A MORE SOLVENT BANKING UNIVERSE

Naturally enough, the government’s socially oriented legislation did impact banks’ earnings. Net profits had slumped 43.1% year on year to $34 million by February 2013 from in 2012 $60 million. Meanwhile, costs including taxes climbed 11.4% to $438 million in February 2013 from $393 million in the same month of the previous year. Some lack of confidence in the banking system also registered early in 2013, as savings accounts growth declined to 12.7% in February, down from 20.4% year on year. Yet, capital flows in Ecuador as reported by the ECB rose to $2.1 billion in 1Q2013 from -$23 billion in 4Q2012. Capital flows averaged at -$30.40 million from 1994 until 2013, with a historic peak of $2.1 billion in February of 2013, having troughed at -$5.6 billion in August of 2000. According to official data, assets in the banking system totaled $27.70 billion in March 2013, while liabilities were $24.92 billion. Arturo Hidrobo Estrada, Executive President of Banco Capital, told TBY that, “The banking system in Ecuador can be seen as strong and solvent, able to adapt quickly to the demands of both the market and regulatory bodies.” He attributed this for the main part to prudent management.

Since November 2012, the ECB has ensured that all international cash transfers to Ecuador flow through accounts at the central bank. This form of currency control could foretell the ultimate replacement of the dollar by a new Ecuadorean currency.

According to IMF data, the average bank assets to GDP ratio from 1961 to 2011 was at 21.04% with a minimum of 13.12% in 1990 and a maximum of 39.66% in 1999. Average non-performing loans as a percentage of total bank loans from 1998 to 2011 was at 9.19%, with a minimum of 3.2% in 2011 and a maximum of 31% in 2000. The average value of assets of foreign owned banks as a percentage of total bank assets from 2004 to 2009 was 11%, with a maximum of 13% in 2007. Foreign-owned banks as a percentage of the banking system was at an average of 17.2% from 1995 to 2009. About 9% of total profits in the sector as of March 2013 came from foreign banks operating in Ecuador, which includes the US-based Citigroup, Dutch-German Procredit Bank, and Panama’s Promerica.

RETURNS, BUT AT WHAT COST?

Ecuador’s Programa de Finanzas Populares of 2008 aimed to expand lending to smaller financial cooperatives, and in turn lend more to small businesses. Co-op loans tripled in real terms between 2007 and 2012, accounting for 19.6% of private bank lending by July 2012. Prior to these reforms, microcredit interest rates had been as high as 100% annually. A source of risk, however, cooperatives in Ecuador are largely unregulated. Their popularity has stemmed from higher rates of return of up to 4% above the traditional banks, despite their deposits not being insured by the national banking system. A run on one of the few cooperatives regulated by the BCE, JEP, in 2012, highlighted their volatile nature. Related reforms being considered include the imposition of a cap on interest rates that cooperatives can charge borrowers, which could in turn spell a reduction in the interest rates offered to depositors.

Established in 1906 in Quito, Banco del Pichincha is Ecuador’s largest private bank. It posted 2012 net assets of $8 billion and liabilities of $7.3 billion. One of the key sources of woe for Ecuador during the global financial crisis had in fact been the drying up of remittances from citizens abroad. The bank provides a comprehensive range of retail banking services, and had a 721 ATM network. It opened a network of customer service centers in Spain in 2007 to cater to the three-quarters of a million Ecuadoreans living there. In 2011, Pichincha commenced retail-banking operations in Colombia and Spain to exploit bilateral trade relations between the two countries and Ecuador. The bank also has representative offices in Shanghai, Panama, and the US.

A pioneer of electronic banking to enhance customer experience, Produbanco is one of Ecuador’s key financial institutions. Today, its automated system assesses more than 4,500 consumer credit and mortgage applications per month. For the year of 2012, the bank had total assets of $2.9 billion, up 15% year on year. Loans were up 15% year on year at $1.3 billion.

Banco de Guayaquil, founded in 1923, is Ecuador’s second largest private bank, with some 600,000 clients, around 200 branches, and 800 ATMs. It provides a comprehensive range of services, including corporate, personal, private, and transaction banking. The bank ventured abroad in 2007 by opening a representative office in Madrid, and subsequently in Panama City in 2008. As of September 2012, the bank had an ATM network of 794. Assets were at $3.4 billion. Commercial, retail, and micro-credit stood at $630 million, $935 million, and $57 million, respectively. Liquidity was at 28.6%, while profitability ROE was at 13.7%. The breakdown of loans was commercial 35.23%, retail 52.30%, residential 9.09%, and microenterprise 3.16%.