From Boom to Bust…and Back Again?

Ecuador’s banking sector is gradually recovering from the worst crisis in its history. Billions of dollars that fled the country three years ago are making their way back. Bad loans are being brought under control. Better risk management is improving the quality of new loans. Injections of cash from shareholders are helping to bring many banks into line with international capital requirements. But it will be some time before confidence in the system completely recovers from the denting it took during 1999. “The private sector banks are doing well,” says Leopoldo Baez, general manager of the Central Bank. “They are stronger and more careful than they were before. But they still need to strengthen, and there are still too many banks.”

The sector has already shrunk by more than half. Out of 43 banks operating three years ago, just one public-sector and 20 private-sector banks survive today. Those that have gone were swept away in the economic collapse of the late 1990s, brought on partly by the el Niño weather phenomenon of 1997 and the collapse in the oil price in 1997-98, and exacerbated by the government’s loose fiscal and monetary policies. Adding to the problem was the fact that banks, businesses and politicians were all in each other’s pockets.

“The banking sector was extremely open,” says Juana Ordónez, general manager of Multiplica, a Quito consultancy. “About 30% of loans were to businesses owned by the same people as the banks. There was a lot of pressure for devaluation and inflation. Banks were driving the sucre down just to survive.”

Several institutions contributed to the 1998 election campaign of President Jamil Mahuad, who kept the printing presses running so fast that security vans would line up outside the Central Bank to take money to the banks. But confidence collapsed. A run on deposits quickly sent several banks under; in March 1999 the government froze deposits to try to save the rest. The erosion of those deposits under subsequent devaluation is one reason many Ecuadorians are still wary of leaving their money tied up in longer-term accounts. But the effect of dollarization on confidence was extraordinary. The run on deposits stopped over night.

Deposits Grow … But Lending?
“With dollarization, people started to deposit again, and private banks benefited from withdrawals from the public-sector banks,” says Santiago Bayas, treasurer at Banco del Pichincha, Ecuador’s biggest private-sector bank.

Nevertheless, the surviving banks still faced problems. The collapse of the economy in 1999 devastated loan portfolios. At the end of 1999, the rate of non-performing loans in the system was as high as 70%. In the one public-sector bank now operating, Banco del Pacífico, it remains an extraordinary 45%. Among the private banks, the average rate is much lower, but remains very high by international standards at more than 9%. Some private banks have non-performing loans rates of more than 30%.

“Since the crisis the financial sector has had to adjust,” says Baez at the Central Bank, “and adjustment of non-performing loans has not been as diligent as we would have liked. The situation has improved over the past six months, but more adjustment is still needed.”

In fact, the growth in deposits over the past two years has not been matched by growth in lending. One reason is that banks need to maintain high liquidity given that, since dollarization, the Central Bank is no longer a lender of last resort. (A liquidity fund has been set up to take on part of this role, but needs further development.) Average liquidity among private banks is 35% of deposits up to 90 days; in some banks the rate is more than 100%. “Their main objective now is to recover the confidence of their customers,” says Vanessa Brito, banking specialist at Multiplica.

Another reason for the low level of lending, says Vicente Vallarino, director of financial planning at Banco Bolivariano in Guayaquil, is that “there is no widespread demand for credit. There is no channel to use our liquidity to benefit the productive sectors.”

Macosa Taps Local Market
Part of this is caution. There is plenty of demand for risky credit, but most banks have improved their risk management systems and won’t take it on. But Vallarino says both local and foreign companies will be reluctant to invest while Ecuador’s regulatory framework remains inadequate. “Companies need to have long-term confidence in the financial, political and economic systems. We need very clear-cut rules for investment,” he says.

There are some exceptions. Santiago Bayas at Banco del Pichincha points out that local companies such as Macosa, a software firm, have placed a handful of bond issues on local markets worth about $15 million since 2000. Most have been bought by mutual funds. But these are rare events on Ecuador’s capital markets. Activity on the Guayaquil and Quito stock exchanges, for example, is close to zero.

Even if banks were disposed to lend more, however, the growth of available funds remains timid. Much of the money that has entered Ecuador since dollarization is in the form of remittances from Ecuadorians who have emigrated to Spain, Italy and the US. These amounted to $1.4 billion in 2001; the figure is expected to reach $1.5 billion in 2002. The real numbers may be much higher, as the Central Bank only keeps track of remittances in cash. The figures do not take account of purchases made by Ecuadorians overseas on behalf of family members back home, who then collect the goods in Ecuador.

Not all the cash sent home ends up in the banks. The current boom in big-ticket consumer spending, such as on housing, cars and electrical goods, is partly fueled by remittances. Moreover, most of the money that does go into bank accounts is going into demand deposits rather than term deposits (see chart on page 22). Says Vallarino at Banco Bolivariano: “The mental state of the small investor is geared to the short term. Risk aversion in the Ecuadorian investor is related to time. Small investors prefer a 30-day account paying less interest than a longer-term account simply because of the term.” Getting investors to change their outlook is a question of confidence in the wider economy.

International Standards
Although it has been restricted by this lack of confidence in the economy, lending is growing slowly. But interest rate spreads remain high by international standards. Corporate lending rates are about 15%, while 90-day deposits pay about 6%. These spreads will remain the main source of income for banks during 2002 and beyond, although most are making strong efforts to increase revenues from fee-paying services.

Meanwhile, the industry continues to restructure. The Central Bank is keen to see banks come into line with the Basle capital adequacy requirements. Some are already close, but it has meant fresh injections of capital from shareholders and is likely to mean more this year. Banco de Guayaquil, for example, undertook a capital injection of $10 million last year; Banco Bolivariano raised $3 million. Consolidation is also likely to continue through mergers and acquisitions, though the days of crisis consolidation appear to be over.