An Outsider Speaks His Mind

I have always been an outsider to Latin America. When I was appointed to head my bank’s operations in the region in 1994, I had little affinity with the area, its history, its culture, its people and certainly not with its financial systems and institutions.

My background was North-Western European and so was my professional orientation. I still have the lingering suspicion that this was part of the reason why ABN AMRO wanted me in Latin America. An outsider’s fresh perspective was needed to review our extensive operations there. They may have been extensive, but in 1994 they were certainly not very profitable. But today, Latin America represents 15% of our global profits, which have more than doubled over the period as well.

Over the last six years, tremendous changes have taken place in Latin America. Since the mid 1990s, most of Latin America has shed its preoccupation with its not-so-glorious recent past, and focused on how it can build a new future and discard its former introverted and introspective mentality. To some extent, this trend continues as Latin nations are still trying to reinvent themselves.

At the same time the United States and Europe have begun paying far more attention to their ties, interests and economic connections with Latin America. This is true not only for politics and trade, but most certainly for our own industry: financial services.

Privatization has of course, prompted governments to question whether they should have a role in providing financial services to a wider public. A related issue, one that is rarely debated, concerns the proper role for state-run financial institutions in a liberalized financial market. What a pity that most state-owned banks have mismanaged their attempt to compete with private sector banks instead of providing basic financial services to low-income households, services which are not normally provided by the private sector.

More to the point, though, relates to the issue of how privatization has opened the way for greater participation by foreign banks in many countries’ financial systems, and how the incursion of these international banks is threatening the future of many of their locally owned competitors.

Most important, years of sustained economic and political reform in Latin America’s main economies has led to a marked improvement in the business environment, which has naturally made these countries more attractive to foreign investors. The end of a protracted period of economic turmoil and high inflation has led to a restructuring of the financial sector in many countries. Brazil has made considerable progress in rebuilding its banking system and in November 1998, ABN AMRO acquired Banco Real, the country’s fourth largest bank, for $2.1 billion.

As a result, local banks have found themselves in a transitional period, characterized by the privatization of state-owned banks, the arrival of new foreign-owned competitors and by new capital requirements imposed by local regulators.

Furthermore, economies have been growing somewhat irregularly with the exception of Mexico and Chile. One feature of growth patterns in emerging economies is how their financial systems grow at a faster rate than other sectors of the economy.

We calculate that in Brazil, annual GDP growth of 3% implies that banking services will grow by about 9% a year. Of course, this additional growth requires more capital, which helps account for the growing role of foreign banks in Latin America.

These international banks like the region much more than they did in the past. There are fewer barriers to entry, local banks are up for sale and additional capital is badly needed. The large multinational corporate customers of international banks demand global service.

Furthermore, we have seen how in many countries, private sector companies, especially the larger ones, are now under foreign control, even more so after the first wave of privatization of the telecom and power sectors. Meanwhile, economic and political fundamentals are all pointing in the right direction. So, perhaps, there should not be such great surprise over the growing presence of foreign banks in the region.

How to Survive
A key question then is how local banks can survive in this new and more challenging environment. On the face of it, this question should not be particularly relevant these days. Ownership of a bank is probably less important than the way it behaves in any given local market. The way banks operate is largely determined by the local regulators, or if one wants to be negative, by the natural tension between the regulators and a bank’s management. And there is little doubt that it is usually the local regulators who come out on top.

Market dynamics have a profound effect on the way banks work, yet many countries, with the exception of Argentina, still view local control of their banking systems to be an issue of national sovereignty. The arrival of a new wave of foreign investment in Latin America’s financial system has rekindled the debate over control. Unfortunately this debate is somewhat fruitless.

To survive, locally owned banks can take one of two strategic decisions.

A large local bank that feels it can compete with the foreigners can overcome its potential shortage of capital by following state-of-the-art corporate governance rules. This would involve, among other actions, listing on a stock exchange with sufficient depth, such as the New York Stock Exchange. This suggests that the local bank would also have a reasonable percentage of foreign shareholders. It would also be large enough to afford the same technological platforms used by its foreign competitors. And last but not least, it would be large enough to offer young, able and professional managers the prospects of an exciting career.

Clearly, this approach is valid for only a handful of Latin America’s banks.

Smaller, more specialized banks may decide to concentrate on a certain type of product, customer or even geographical area. It is worth noting that regional banks are among the most successful banks in the US. There appears to be no specific reason why local banks, highly specialized in their region should not be able to continue competing with international banks. Technology has ever-lower economies of scale. However, one of the conditions for the survival of these local banks is that they concentrate solely on what they consider to be their core competency.

Latin America’s banks must therefore decide to remain, or become, large enough to compete in a more demanding regulatory and market environment in which foreign competition will be the benchmark they must meet. Alternatively, they may decide to specialize, either by type of product, by type of client or by limited geography. However, their shareholders may also decide they must sell out and deploy their capital in more profitable areas.

Well-managed local banks certainly have the luxury of choosing which option suits them best. Indifferently managed banks do not. But then, no region, country or client deserves – or will tolerate – indifferently managed banks for long.

And if one accepts that indifferently managed banks should have no future, then one must also accept greater concentration of bank ownership, whether banks are foreign-owned or locally owned. Globalization has also struck in Latin America and in the long run, more competition must benefit the consumer, our clients. Less competition certainly will not benefit our customers.

Room for All
Latin America is of course large enough, as a market, to accommodate foreign banks as well as local banks be they large, small or specialized ones.

It is clear that ABN AMRO’s acquisition of Banco Real represented a milestone in the debate. Prior to that, no foreign bank had established itself in the upper reaches of the Brazilian banking system that is still dominated by locally owned private and public sector banks.

As a provider of financial services, we and our shareholders will only benefit if our current and future customers believe our services are worth buying. That is the ultimate test for any banker. And as a banker, in the six years I have spent working in Latin America, I have seen how more and more customers are willing to do so. This growth has benefited ABN AMRO and the sector as a whole. If it has not always been easy-going, it has certainly been well worth it.