Keeping Damage to a Minimum

High interest rates, a currency in free fall, nervous customers and volatility: these conditions sound like just the environment for canny bankers to make a killing. With money market rates as high as 20% last year, Venezuela’s banks were able to sit happily on their stocks of government debt and see profits rise. This year, their holdings in US dollars have given them a one-off windfall from the February devaluation of the bolivar. Interest rates, though lower than last year, also remain high. For the first five months of the year at least, profits were as good as last year’s.

But the conditions aren’t set to last. “We knew this year was going to be a bad year for the economy and for the banking system,” says Ignacio Salvatierra, president of the board of directors at Unibanca, one of the top local Venezuelan banks. “And that is what is now going on. It’s all to do with the economic and political situation in the country.”

José Grasso of Softline, a Caracas banking consultancy, says the good news is that banks have been making more money from high interest rates. “The bad news is that high interest rates are having an effect on the quality of their credit portfolios,” he says. ” There’s less demand, and non-performing loans will increase.”

Indeed, delinquency rates are already on the way up. The rate of past-due loans for the financial system as a whole was 7.7% at the end of March, two points higher than at the end of 2001, according to the Superintendency of Banks. Luis Oganes, Latin American bank analyst at JP Morgan in New York, expects the figure to reach at least 9% by the end of 2002 and thinks the true rate is already at about 8.5%.

At the same time, deposits are slipping. Salvatierra says deposits across the system fell by 12% during the first half of 2002. The reason is that Venezuelans are losing faith in the bolivar. There are no official figures, but people in the industry estimate that capital flight from Venezuela last year totaled between $8 billion and $10 billion. This year it could be worse, predicts Oscar García, chairman and chief executive of Banco Venezolano de Crédito. “The government has been keeping interest rates high to avoid capital flight,” he says. “But now it has to bring them down because everybody is feeling the pain, whole industries are shutting down.”

Lower interest rates also will mean lower profits for the sector. “We forecast a reduction in our profits in the second half without any doubt,” García says. “The first half has been very good, because our [spreads] are huge, and also because we made money from the devaluation, thanks to our position in dollars.” At mid-year, corporate borrowers were paying about 35% for 30-day loans. That’s high by any standards, but a lot lower than the 55% to 60% they paid at the start of the year.

Venezolano made profits of $40 million last year on equity of $131 million. García won’t put a figure on likely profits in 2002, but he says earnings from financial intermediation have fallen by almost 50% in the past two years.

For Gustavo Marturet, chairman and CEO of Banco Mercantil, the key to dealing with Venezuela’s economic and political situation is caution. “Mercantil’s policy has always been that when the national situation deteriorates, we increase provisions,” he says. Mercantil Servicios Financieros – the group that includes Banco Mercantil as well as an investment bank, insurance company, brokerage, and Miami-based Commercebank – ended 2001 with a non-performing loan rate of 2.96%, and coverage of 179%. The bank itself had a non-performing loan rate of 3.55% and coverage of 180%. That’s remarkably conservative, even in a financial system with an average coverage ratio last year of 127% – although the ratio has recently fallen to about 108%.

Staying Strong
This kind of caution means that Banco Mercantil has often sacrificed profits to keep the bank in a strong position. “The important thing is to have a long-term approach,” Marturet says. “You have to be always aware of the volatility of this economy. And you have to achieve a higher return on equity with, first of all, solvency – meaning the quality of the bank – and, secondly, with quality of service. It’s easy to get a higher rate of returns with poor services, but it wouldn’t get you very far.”

In fact, Mercantil’s rate of return is high compared to many banks in developed economies – it was 20.6% at the end of the first quarter, a huge improvement on the 8% level at the end of 2000. Profits were $98 million, up from $51 million in 2000. Other Venezuelan banks have done even better: Venezolano de Credito’s return on equity was 30%.

But with the decline in interest rates threatening to seriously curtail profitability, many banks have shied away from some forms of lending altogether. Says Oscar García at Venezolano de Crédito, “We started reducing our exposure to credit last year in anticipation of a worsening situation. We’re a corporate bank, so we deal mostly with multinationals and big local companies. But we do also offer loans for automobile purchases and real estate. We’ve avoided all that kind of thing for the past year-and-a-half.”

Grasso, of Softline, says that across the banking system, lending accounts for just 45% of assets. The remaining bank assets go into government debt and reserve requirements at the Central Bank, which although they were recently cut to 15% from 17% still take a considerable bite out of banks’ available assets. While many banks in Latin America are weaning themselves away from government debt as their main source of income, the recent trend in Venezuela has been in the opposite direction. The percentage of assets in the banking system devoted to credit operations peaked at just under 50% in December 1997 and has been trending down ever since.

That leaves banks looking for other sources of income. Mercantil has one valuable asset in the form of Commercebank, a Miami bank it bought in 1987. Its assets have grown rapidly, rising by 31% in 2000 and 7.7% in 2001 to reach $1.68 billion at the end of last year. Account holders at Mercantil and Commercebank can use the Internet to shift money between accounts, providing a quick and easy way to convert bolivars into dollars much prized by Mercantil’s customers, although Marturet says there is just as much movement in the other direction. It’s common practice in Venezuela for salaries to be converted into dollars on payday and converted back again later as necessary.

Work Ahead
Despite its relative strength Venezuela’s banking system in still has a lot of work to do to secure a stable future. Its first task, says Grasso, is to achieve a solid capital base. He thinks Mercantil’s above-average capitalization would be about right for the industry as a whole (the legal minimum in Venezuela is 12%). Grasso says that banks also need to improve the quality of their loan portfolios. “We need more professional risk management, especially for credit risk,” he says. “We need to be more aware of the impact of the economy on our customers.”

Improved credit quality needs to be accompanied by lower expenses, says Grasso, which means teaching customers to use less expensive, high-technology services, rather than traditional services like checks. Old-fashioned services are especially expensive in Venezuela, where retailers must confirm all check transactions by telephone with the customer’s branch, and where shops have a different point of sale terminal for each bank. Quality of service in banks must also improve. As in banks across Latin America, long lines at service desks are a common sight.

Although the number of banks in Venezuela fell to 71 at the end of last year from 104 four years earlier, further consolidation is likely. Unibanca and Banesca merged early in the year, and in May, Banco de Venezuela and Banco Caracas followed suit. That leaves Banco de Venezuela, controlled by Santander Central Hispano, in first place in terms of total assets, with Unibanca, set to rise from fourth place to second. The other two of the big four are Banco Provincial, controlled by Banco Bilbao Vizcaya Argentaria, and Mercantil.

“The difference between the top four is very narrow,” says Unibanca’s Salvatierra. “About 45% of the system is in foreign hands and about 55% in local hands. In terms of competition, it works well to have two big foreign and two big local banks, it helps us to improve the quality of our portfolio, of our services.”

There could well be more merger activity, or even closures, among smaller banks, especially if, as Oscar García at Venezolano expects, there is a flight to bigger banks by nervous customers. Smaller banks with low levels of capitalization may find themselves forced to merge in order to survive.

Directed Lending
They could be pushed into doing so by the new banking law issued by President Chávez last November under special enabling legislation. It requires all banks to raise their capital ratios, a move that the big banks have welcomed because it will help solidify the system. But the law is controversial, not least because it obliges banks to dedicate at least 15% of loan portfolios to farm lending. The main complaint, though, is that the law is extremely detailed – it has 520 articles – and was produced without consultation with the banking sector, analysts, academics or anyone else. Banks have been given a year to adapt to the law, but bankers hope it will be modified in the package of 17 of Chávez’s laws now up for discussion.

“The banking law is pretty bad,” says García. “The last thing we need is a law with more than 500 articles. What we need is proper banking supervision. The Superintendency of Banks is doing a better job than it was, but what is missing is the political will to have a properly structured and supervised banking sector.”

Marturet says Mercantil is working hard to modernize its services and to persuade customers to move to more technology-driven services. Use of Internet banking remains fairly low – it was introduced at the end of 1997 and now accounts for 11% of transactions. But the proportion of transactions undertaken with traditional services has fallen to just under a third. Marturet says there is some resistance from customers. One problem is that they are accustomed to using checks, so it is hard to suddenly start charging for the service. What Mercantil will do is start charging for checks used over a certain number in a certain period. Customers are also fairly new to ATMs, and tend to check their balance, make a withdrawal, and check the balance again, “just to make sure.” So what should be one transaction turns into three.

Getting customers to use more services will be even harder, however, if the government succeeds in raising the financial transactions tax to 1.0% from the current 0.75%. García says the tax is already a major disincentive for people to use banking services. “The tax has caused a decrease in the number of operations that banks do and an increase in cash transactions,” he says. “People pay and get paid in cash, even some small companies are using cash. Increasing the rate will make that worse. And it will also lead to a big recession.”

There are other developments outside the sector’s control. Banks like Mercantil would like to be able to offer private pension plans, but Venezuela lacks legislation to make this possible. There is hope that the new cabinet will make progress on this issue, along with so much else that affects the banking sector and the economy in general.

Ignacio Salvatierra at Unibanca, says Venezuela’s biggest problem is not with the banking system. “As an industry we’re in quite good shape,” he says. ” The problem is with inflation, unemployment, the general economic situation of the country. The nation worries about that, not about banks. But the situation also has an impact on us. Our job this year is to try and keep the negative impact to a minimum.” w