The announcement on December 4 that Ecuador’s second largest bank in terms of assets, Filanbanco, would have to be intervened perhaps sent the strongest message so far about the nation’s long-troubled financial system-not only were banks facing a severe liquidity crisis, but the sector’s solvency was also under question.

The central bank is said to have injected more than $150 million in emergency loans to keep Filanbanco afloat before being forced to close the distressed bank’s doors. But that is only a drop in the bucket compared to the $540 million that authorities say they will need to restructure and recapitalize Filanbanco.

Such volatility, nevertheless, has done much to spur a well-needed dose of consolidation activity in this country of 12 million people, where most observers reckon that half of the 40 banks in operation are obsolete. Already, within a space of a month last autumn, three such deals were announced, including the headline-grabbing merger of the country’s fourth and fifth largest financial institutions, Banco Pacifico and Banco Popular, a marriage which was to have spawned Ecuador’s largest bank with $2.7 billion in assets. Yet on January 7, the banking superintendent ruled the merger could not proceed until a dispute between Banco Pacifico and a small group of its shareholders had been resolved. A spokesperson for the bank, however, told LatinFinance that “the merger will go through in any case.”

Nicolas Landes, president of Popular and the named executive president of Banco Pacifico-Popular SA, says that Ecuador only has room for four or five large nationwide banks-half the amount of such banks currently operating in the country.

It seems that others agree. Following the announcement of the Pacifico-Popular merger, Ecuador’s Produbanco, the ninth largest bank, said it would buy an unnamed rival to expand its market share. Not to be outdone, Banco de Progreso, formerly the system’s number one in terms of assets, then made its move, confirming that it would take over Banco Cofiec to create what will be Ecuador’s second biggest financial institution. If approved, the merger will beget an institution with some $1.15 billion in assets and a 20% market share in deposits. Banco Cofiec had originally been in discussions with Popular and Pacifico regarding a possible three-way merger, but withdrew after receiving a sweeter deal from Progreso.

Meanwhile, said Landes, the shareholder issue at Banco Pacifico shouldn’t affect the merger.

Some of the foreign investment funds holding Pacifico stock approached the board in the wake of the merger decision and wanted to sell back their stake at 800 sucres per share, which was book price, when the market was pricing the shares at 500 sucres per share.

The bank, which would not buy back shares above market value, views it as an attempt by the fund managers to make several extra million dollars from the sale.

One of the investors involved, speaking on condition of anonymity, said that the concept of the merger was very attractive, but that Pacifico and its shareholders were being taken advantage of by the terms of the deal. He was hopeful that the issue could be resolved and the merger would continue, since their opposition was to the terms of the deal and not the deal itself.

In the midst of this merger-mania, the Ecuadoran Congress has also made moves that may strengthen the banking sector. It has recently refused to renew a three-year-old ban on the creation of new banks, thus allowing foreign financial institutions to once again enter the country. Among the foreign banks already operating there are ABN Amro, ING Barings, Citibank and Lloyd’s Bank, but those foreigners who want to set up shop will be required to have $20 million in start-up capital. There has been a lot of interest among international banks regarding the future sale of the restructured Filanbanco. And although the former owner, the Isaias family, is reportedly interested in re-acquiring the bank, it is rumored that Banco Santander and other foreigners are considering the acquisition.

While most Ecuadoran banks are focusing only on the wave of coming mergers and acquisitions in their own country, at least one is looking into cross-border activities. Banco del Pichincha is expanding into Peru where, according to Pichincha’s general manager Antonio Acosta Espinosa, the bank is acquiring 35% of Banco Financiero del Peru, something which the peace accord between Peru and Ecuador has facilitated.

Signs of Trouble
Falling oil prices, the Asian crisis, and the lingering effects of El Niño on the country’s number-one export crop, bananas, all have taken their toll on Ecuador’s banking sector.

By late 1998, banks (many of them relatively small) were facing a true tempest in their non-performing loans. According to the central bank, Ecuadoran banks held $320 million in bad loans by the end of September last year, a 38.4% increase over the same period a year earlier. Such problems were exacerbated by the precarious state of oil prices, which fell by almost 50% between October 1997 and October 1998 and hit hard those banks that traditionally serviced loans to the oil sector. Among the first victims was the now-defunct Banco de Prestamos, which the government closed down in August.

Eventually the pressures became so great that other banks began to buckle. After Prestamos’ intervention, even Banco del Pacifico suffered a run on its deposits, fomenting doubts about the health of what was considered a relatively strong bank. Such insecurity was particularly unsettling for a weak and overbanked financial system, which observers note has been protected from foreign competition and lacked a legitimate watchdog agency.

Deposit Guarantees
To remedy such problems, the government of recently elected President Jamil Mahuad Witt established the Deposit Guarantee Agency, a new banking regulator with wide-ranging powers to intervene in the management of under-performing banks. While the agency reviews the health of the nation’s banks, the government is insuring all deposits for three years. With an agency that guarantees deposits, the hope is that runs on deposits will decline and fear of any losses will subside.

Pichincha’s Acosta said the work of the new agency will provide a “crystal clear x-ray” into the health of the sector and will serve to strengthen it greatly. Landes added that Ecuador had always lacked an FDIC-type agency and that the problems with Filanbanco were a catalyst for Congress to finally create such an organization.

In addition to the creation of the deposit guarantee agency, the government has also promulgated a plan to swap bad bank debt for government bonds. Because of this and other reforms by the government, optimism is returning to the business sector.

A Deloitte&Touche survey of Ecuadoran businesses reveals that 70% favor the government’s actions so far. The level of pessimism across the country has fallen from 35% to 4%, as measured by the survey.

One entity that still is more cautious than optimistic is Moody’s Investors Service. In September, the agency downgraded Ecuador’s rating on foreign debt from B3 to Caa2. All B1-rated foreign currency bonds were immediately downgraded to B3. The downgrade was based on concerns that the large accumulated fiscal imbalances could lead to a rapid build-up of government bonds denominated in local currency to finance it. Furthermore, according to the credit rating agency, while the government’s plan to intervene troubled banks and maintain stability is laudable, it may create a moral hazard. “It is absolutely necessary that shareholders and managements take the responsibility for their poor behavior and see their equity written down,” the agency said in a report.

“In Mexico, if it will be recalled, the largest portion of Fobaproa (the bank bailout fund) liabilities relates not to the banks that have survived, but to those that were either corrupt or non-viable, and which disappeared,” added the agency. “In the Ecuadoran situation, the government needs to limit the amount that could be stolen from the bailout.”