Finding Sustainable Growth

When the finance minister states one day that the banking sector is “solid and healthy” and the president of the country’s largest bank reiterates this the next, no one could be blamed for thinking that something might be amiss. Ignacio Guerra, chief financial officer of Banco Popular, the largest bank in the Dominican Republic, admits there is growing anxiety about the weakening global economy and its effects on the financial system. “Growth in the country has slowed down and high growth rates have decelerated in some activities like construction,” he says. “When there is an environment generally characterized by uncertainty, these things are magnified.” One reason for the public reassurances could be the remarkable growth that the commercial banks in the Dominican Republic experienced last year. Total net income for 2001 was around $200 million, an increase of 56% over 2000, with banks reporting an average return on equity of 22.1%. Total bank lending in 2001 grew by 33%, the highest rate in the past four years, and loans grew to 34% of GDP, twice as much as in 1995.

The country’s 12 commercial banks command a 74% share of the financial system’s assets. There are an astonishing 152 financial institutions in the country of 8 million people, including savings and loans companies, development banks, financing companies and small lending institutions. Lower interest rates last year, which had started to decline at the end of 2000, fueled a lending boom. Average interest rates on loans fell to 21% at the end of last year from 29% at the end of 2000. The banks had to cut back on lending when the central bank raised interest rates to drain some liquidity out of the system in the first quarter, but they still posted healthy results.

Bankers agree that a slowdown in growth would not be a bad thing for the banks. Says Guerra, “Now is the time for conservative growth and that is a reflection of the overall economy. It is not the time to [continue] the growth in loan rates of recent years. We will see that the whole sector is conservative this year in terms of growth.” Indiana Jones, head of treasury at Banco de Reservas, a public commercial bank and the second-largest in the country, says, “The DR had the fastest growth in the region for the last four years, and although we would still like to grow, it is not healthy to grow much faster than the US economy. It is better for us to grow sustainably.” Growing faster than the US economy could overheat the economy. Over the last five years, the banks’ loan portfolio has expanded at twice the rate of GDP growth. Even so, the country’s commercial banks are in good shape. Total banking system solvency, measured by their risk-weighted capital ratio, was 11.8% at the end of last year, above the country’s 10% requirement.

The slowdown in lending comes at a time when the banks are preparing to implement the long-awaited monetary and financial legislation, which Congress is due to approve soon. The law should have a sobering effect on the sector by imposing international accounting and regulation standards on the banks. “Deceleration in growth is a good pause for the banks to adopt the new measures and grow healthily,” says María Teresa Beyra, financial institutions analyst at Standard New York Securities in Miami. The new legislation will make the Central Bank an independent institution, liberalize foreign currency regulations, create prudential banking regulations in line with the Basel consensus and force commercial banks to adopt accounting practices in line with the International Accounting Standards Board. For instance, banks previously estimated past due loans on a cash basis and will now have to make estimates on an accrual basis, taking into account not only the interest owed but also the principal. In fact, the authorities have already begun to phase in the new rules. Last year, the banking superintendency and Central Bank introduced new regulations requiring banks to present their accounts on an accrual basis instead of on a cash basis. It also required banks to adopt new risk classifications for their loan portfolios as well as new criteria for provisions.

But bankers insist that little will actually change once the law comes into force, since the main banks are already following similar rules voluntarily. “We will not so much see a deterioration in the portfolio, but in the presentation of the numbers,” says Banco Popular’s Guerra. Felipe Mendoza, chief executive officer of Bancrédito, the fourth-largest private-sector bank in the Dominican Republic, says, “We already have stronger loan [risk] classifications in place and have changed our accounting methods, so that will increase our provisions to past due loans ratio. The percentage will of course be higher and have an impact on net profit because we were accounting on a cash basis and now will account on an accrual basis.”

Clean Portfolios

The percentage of loans in arrears is remarkably low in any case. Past due loans were equivalent to only 1.65% of the banking system’s total portfolio in December last year, down from 1.96% the year before. Its risk-weighted capital ratio is 11.8%, above the 10% required. The banking sector has a liquid assets-to-deposits ratio of 32%. Even so, the banks look more vulnerable when one examines their loans-to-deposit ratio, which averages 96%. And there has been some deterioration in their liquid assets-to-deposits ratio, which was 32% last year compared to 36.8% at the end of 2000.

A slowdown in lending coupled with a more diversified loan portfolio would be healthier for the banks in the long run. The public sector was the biggest commercial bank borrower last year, accounting for 20% of loans. Manufacturing companies accounted for 16% of all new loans and construction companies 15%. Several of the largest Dominican Republic banks belong to large conglomerates and the pending legislation would also reduce related party lending. For instance, Grupo Bancrédito, which owns Bancrédito is owned by or has interests in Segna, the country’s largest insurer and Tricom, the country’s second-largest telecommunications company as well as Zona Franca San Isidro, a free zone operator. The new legislation defines a related party as any entity holding a share of 5% or more in a bank. Under the current system banks can make loans equivalent to 30% of their capital and reserves to one entity and 15% on an unsecured basis. These limits will be reduced under the new code to 20% on a secured basis and 10% on an unsecured basis. This should reduce their concentration on a few companies and diversify their exposure to companies.

Banks expect retail lending to become an important part of their growth in the years to come. Bancrédito has the country’s largest retail network and is gearing up for expansion. “Our retail business is dynamic and growing. We have doubled our branch network in the last three years,” says Mendoza. Retail lending already represents 60% of Bancrédito’s total loan portfolio and Mendoza says credit card lending is now becoming its fastest-growing business. The bank commands 36% of the market for Visa credit cards. It has around 350,000 credit cardholders and around 150,000 debit cardholders. Banco Popular ranks second in credit card lending with a 22% market share. Mendoza says Bancrédito recently introduced automatic credit scoring technology to process the hundreds of credit card applications it receives daily.

Investing in technology is becoming increasingly important to commercial banks. Technology can make them more efficient by reducing their cost-to-income ratios, which averages 67%. Banco Popular upgraded its technology infrastructure to be Y2K compliant and has continued to overhaul its technology infrastructure. Bancrédito’s Mendoza says investing in technology should be a priority for Dominican commercial banks. “As long as the DR market continues to grow soundly and transparently, we will have [foreign banks] here competing,” he says. “That is why we must develop strong capabilities in technology.” Bancrédito is investing between $8 million and $10 million in a technology platform to deliver Internet and telephone banking. Mendoza says his bank also wants to develop technology that will enable it to tap into the $2.1 billion flow of remittances that Dominicans working in the US and Europe send home each year. Handling remittances is an important line of business for the banks because this provides them with a steady revenue stream to underpin issuance of high-grade asset-backed securities on the international capital markets. Banks across Latin America have been able to issue long-term, investment grade securities by securitizing flows of credit card receivables and electronic wire transfers in the last couple of years. In October, Bancrédito raised a $38 million, five-year term loan secured on credit card receivables arranged by Union Planters Bank and WestLB AG. Banco Popular’s Guerra says his bank already handles electronic remittance flows from the bank’s corporate clients and views this business as an important area of growth.

Borrowing for the long term is becoming increasingly important for Dominican banks now that they are developing investment-banking capabilities. “Ten years ago there was no investment banking or sub-investment banking in the banks, but now you will find these departments in commercial banks,” says Ramón Tarragó, chief financial officer of Tricom, a local telecommunications company that is listed on the New York Stock Exchange. Until recently, the banks funded lending with loans from foreign development banks such as France’s Proparco and Germany’s DEG, or short-term loans from US correspondent banks. “Until recently, we did not have the need for long-term financing but now we do because we are lending to local projects,” says Guerra. Jones, at Banco de Reservas, says her bank is also considering long-term funding from abroad because the bank wants to develop a mortgage lending business and needs to find funding that stretches beyond the three years that banks typically attract these days. Some banks need long-term funding to participate in project finance lending. Banco Popular has worked with international banks on large loan facilities for some of the country’s biggest international companies, such as Caterpillar, France Télécom’s Orange as well as AES, the US energy company.

The launching of a privately managed pension fund system in February will fuel the demand for debt products with maturities that stretch beyond the 180-day commercial paper companies generally issue now. Securitizing hard currency assets could give these banks a head start in the local market. Luis Espínola, vice president of international financing at Banco Popular, says his bank is interested in a deal to securitize up to $100 million-worth of credit card receivables with a maturity beyond five years. “We are already well-known in the Miami and New York banking communities, but we would also like to take our name to Europe,” he says.