Banking in Bolivia with Riots on the Streets

By Jaime Dunn De Avila

On June 17 Fitch Ratings revised its Outlook rating for Bolivia from B- Stable to B- Negative. Theresa Paz, Fitch sovereign analyst for Bolivia says “the revised Outlook reflects concerns that recent social and political turmoil in that third world country could jeopardize medium-term economic prospects”. Political turmoil and social unrest are nothing new in Bolivia. Widespread poverty, high unemployment, racial discrimination, corruption and the fatigue of the neo-liberal economic model implemented in 1985, are the principal causes of continuous crises and instability since 1998.

The Bolivian banking system is small compared to other Latin American countries, a reflection of the size and poverty of Bolivian economy. In the last few years, the banking sector formed by 13 banks, has suffered five dramatic blows that caused capital flight, an increase in the levels of credit defaults and a persistent shrinkage on the level of outstanding loans. In December 1998, the banking sector had $4.2 billion in loans and $3,5 billion in bank deposits. The first week of June 2005, those figures are $2.5 billion (-40%) and $2,6 billion (-26%) respectively. Since 1998 over a billion in bank deposits have been withdrawn while credit defaults have increased nearly 250%, from 6.5% to 16.3%.

A good portion of the reduction on outstanding loans has been the result of policies carried out by Citibank NA and Banco Santa Cruz (since 1998 owned by Banco Santander Central Hispano of Spain). Since the year 2000, Banco Santa Cruz has gone from being the largest bank in term of assets, to the fifth place today. And at the end of 2004, Citibank NA reduced significantly its banking operations in Bolivia, shrinking its operations to a single branch. In the meantime external financing to locally owned banks has shrunk from $917 million in 1998 to only $98 million today. Apart from Banco Santa Cruz, the three smallest banks in Bolivia are foreign owned. This reflects the tough banking environment in Bolivia that causes foreign owned banks and subsidiaries to move their business elsewhere. At the same time, it shows that having a large international presence maybe a weakness in times of crises, because foreign capital moves out of the country quickly, whereas locally owned banks have to endure the situation.

Undoubtedly the Bolivian banking system has endured many blows recently thanks to the strict bank reform and regulation that began in the nineties, and the fact that the Bolivian banking system is made out mostly of local capital. These facts had a positive impact in preparing the banking system to confront harsh social and political times. Since 1987, all banking regulation and control tasks were separated from the Central Bank of Bolivia (BCB) and trespassed to the Superintendence of Banks (SB). Although the BCB is on charge of issuing important norms applied to the banking system, the BCB is an autarkic institution and its main purpose is to maintain the monetary stability and the purchasing power of the boliviano, the local currency. The SB enforces all norms issued by the BCB.

To ensure the independence of the BCB and the SB from direct government interference, the President of the BCB and all members of its Board of Directors are chosen by the President of Bolivia from a short list of candidates proposed by the Chamber of Deputies of the Bolivian Congress. While the Superintendent of Banks is chosen by the President from a short list proposed by the Senate.

The BCB and the SB have been recognized internationally for having applied good measures of prudence the last few years in order to preserve the health of the banking system under continuous stress. Since May 31 of 2005, a new norm for evaluation and scoring of credits was introduced, replacing the norm established in 1999. Under this new norm, which also paves the road towards Basel II, the SB seeks to strengthen the baking system even more and to stimulate the generation of new loans. The new norm creates eight categories for all loans, from “A” (normal) to “H” (lost). Under the new norm, clients must not only have good guarantees, but must also prove enough sources of income and must have an excellent payment record. The new norm is not without cost, all banks have to invest about 10% of their equity on implementing it.

In the pipeline more banking regulation is in place: the Law of Corporate Governance, of Liquid Assets, Leasing and legislation on tributary matters aimed to protect and encourage more financial activity. On the other hand, newly signed Stand By credits with the International Monetary Funds come with even tougher banking norms that increase previsions and liquidity levels even more. In response, an analyst said, “Bolivia is a country with the economy of a poor African nation, with a US rate of inflation and a Swiss banking regulation”. Others observe that strict norms are in fact the cause of the 40% reduction in

outstanding loans since 1998, because under ever increasing requisites, less people and corporations qualify for a credit. Meanwhile, loan sharking is booming. Looking at the development of the Bolivian banking, we can see that the boom started in 1995 peaked in 1998. The rapid reduction of coca plantations under US pressures, the severe credit crunch to the productive, and poverty exacerbated by declines in informal sector income, shrank the financial system. After 20 years of neo-liberal policies, widespread poverty and reform fatigue, people demand a change in the economic model. As result, in the last five years, Bolivia has had five Presidents. In June 2002, in response to the slim election victory of neo-liberal President Gonzalo Sánchez de Lozada with the shocking second place obtained by Evo Morales, $396 million or 14% of all bank deposits were withdrawn. Morales is radical socialist “coca leaf” leader of the Movimiento al Socialismo (MAS), a shelter for coca-growers of the Chapare region, with demonstrated sympathy of Cuba’s Fidel Castro and Venezuela’s Hugo Chavez. Afterward on February 2003, in response to Sanchez de Lozada´s intention to pioneer the first capital gain tax in Bolivian history, the social unrest, violent rioting and a police mutiny, caused $207 million or 8% of all bank deposits to be withdrawn. Later on October of 2003, after nearly three weeks of political chaos and social unrest, Sánchez de Lozada was forced out of the government, and $242 million or the equivalent of about 10% of all bank deposits were lost.

The fourth crisis happened in the first three months of 2004, when due to the severe fiscal deficit of 9,0% of GDP, President Carlos Mesa proposed the creation of a “financial transaction tax” of 0,3% on all debits and credits on bank deposits denominated in US dollars. Considering that close to 90% of all deposits were denominated in US dollars, the impact in the banking system was large. Since the announcement of the tax until it was implemented on April of 2004, close to $300 million or close to 12% of bank deposits were withdrawn seeking to avoid the tax. However, once the dust settled, bank deposits began to ascend until the most recent political crisis of June 2005, when Carlos Mesa resigned to the presidency to allow a transitional government to call general elections at the end of 2005. During this last crisis that lasted nearly four weeks, $110 million or 5% of all bank deposits were withdrawn. Although this crisis was more profound than the others, considering that even attempts to nationalize foreign oil companies’ assets were considered on the people’s agenda, the effects in the banking system were small. This because bank deposits grew about $103 million during the months of April and May when middle-year dividends paid by large foreign own companies were deposited, and because many bank customers were able to deposit their funds after a short-lived panic caused by the appearance of counterfeited US dollars in the month of March, was finally over. But the dangers prying the banks are not only of political nature; there are also a mismatch between short- term deposits (14 months on average) and long-term loan maturities (up to 25 years). Moreover, close to 88% of all bank deposits and 95% of all loans are denominated in US dollars, while most of the debtors have incomes in bolivianos. This mismatch on currency and loan maturities is also a problem hard to solve because of the high level of “dollarization” in the economy. “Dollarization” is a common term in countries that suffered hyperinflation in the past. It basically means that the US dollar is used on most of monetary transactions within the country replacing the local currency as an instrument of exchange and savings. In Bolivia, dollarization has its origins in the lack of confidence of the public in the boliviano, as result of the 20.000 % hyperinflation of the mid eighties, becoming the largest inflation on record in the world during peacetime.

Moody´s Investors Service rates Caa1/Caa2 in foreign currency to the largest banks of Bolivia citing the “high level of dollarization”. The dollarization of bank loans is harmful and potencially catastrophic in Bolivia because, as we said most of bank debtors have their income in bolivianos while they must pay back their loans in US dollars. Considering that devaluation runs about 6% on average for the last five years, on a 10% rate of interest on a credit you must tack on an additional 6% due to devaluation. That certainly pressures all debtors increasing the levels of loan delinquencies, which have steadily risen in Bolivia from 5.2% in 1997 to 21.5% in 2001, coming down to 13.7% in 2004. Another problem with dollarization is that the Central Bank can hardly play the role of lender of last resort for the banks since it does not issue US dollars and must always maintain high levels of international reserves. According to the BCB, the high levels of dollarization of the economy, forces banks to have about twice the normal liquidity of banks in non-dollarized nations. In response, Bolivian authorities have introduced in 2001 the Unidad de Fomento a la Vivienda (UFV), an inflation-adjusted index that allows for loans and deposits in bolivianos to be adjusted for inflation. The success of the UFV has been moderate, but it is increasingly used on the country, especially since some tax relief has been given to transactions in local currency.

Under the described stressful scenario, the Bolivian banking system had to apply a severe cost reduction strategy, restructure liabilities and implement measures of prudence to avoid liquidity problems. Since December of 2000, administrative costs have been reduced 28% and costs of staff in 33%. At the end of 1998 there were a total of 15 banks in Bolivia with 353 agencies and 6.808 employees nationwide. Now there are 13 banks, about 230 agencies and 4.000 workers. The high level of liquidity (liquid assets over deposits) of the Bolivian banking system has been about 33% for the last five years. This liquidity is mostly invested in short-term government paper, repos and short-term bank deposits in the US. However, the high level of liquidity has affected profitability. On average, Return On Assets (ROA) has been –0,12% and Return On Equity (ROE) –1,5% for the last five years.

Although 2002 and 2003 have been the only profitable years for the banking system as a whole, Bolivian banks have learned to do business with riots on the streets. Banks depend less on loans to generate income and are more service oriented. Important investments in technology have been implemented, cost controls and risk management have become a priority. Banco Nacional de Bolivia (BNB), fully owned by Bolivian nationals headed by the Bedoya family, has emerged as the largest bank in the country with $623 million in assets and 16.77% of all bank loans. For 2004 BNB registered a profit of $2.7 million and $42 million in equity. In a recent interview, Antonio Valda, Deputy General Manager of BNB said that the profitability and solvency of BNB is due to a modern but prudential risk management, to administrative efficiency, to the implementation of a policy to increase the operative income and a change in the way of doing things: some divisions of the bank concentrate in the loan related business, while others are dedicated to the non loan related commercial, international and service related businesses. “Under times of stress the trust of the depositors is the key to maintain the bank divorced of the social problems”, says Valda, and complements his thinking with a vote of confidence: “People trust BNB, we are the oldest bank (133 years) yet the most modern institution regarding technology in Bolivia. It takes a lot of effort and time to be number one; it requires detailed planning and dynamic implementation and we have done just that “.

In the same interview, Alberto Valdez, Financial Manager of Banco Mercantil, the second bank of Bolivia in terms of assets ($546 million), says that their business has found stability because their clients are “corporations and small and medium enterprises that adapt very rapidly to good and bad times”. Banco Mercantil is about 97% owned by Bolivian nationals and about 3% by a Panamanian interest. In 2004, this bank had a profit of $5.4 million and $59 million in equity. Banco Mercantil has also been able to diversify risk and obtain cheaper financing from international banks. Valdez also says that the reduction in administrative costs, innovation and investments in technology have been fruitful. “Banco Mercantil puts first its solvency before profitability”, says Valdez referring to how banks prioritize high levels of liquidity under the country’s circumstances.

In spite of political and social unrest since the year 2000, Bolivia’s economy has improved lately due to worldwide growth and the government’s success of controlling the fiscal deficit. Real GDP growth has been 3.6% in 2004, up from 2.8% in 2003. In 2005, real GDP growth is expected to be at around 4.5%. High international commodity prices and increased export volumes have benefited the country’s external accounts, with export growth reaching 36% setting new records every year. This has resulted in controlled currency devaluation with inflation of 3.2% for the year 2004. As result, the banking system has remained solvent. “We have a social and political crises, but not financial crises” is the official word of the Bolivian Bank Association (ASOBAN), at the same time that warns that the challenges for a better banking system are still enormous. Certainly, the mismatch of currency and maturities is a ticking bomb that must be deactivated.

Jaime Dunn De AvilaChief Executive OfficerNAFIBO Sociedad de Titularización S.A.La Paz-Bolivia_____________________________________________________________________________________

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The high level of liquidity of the Bolivian banking system has dramatically lowered loan rates, especially in the mortgage market. In the year 2000 the average loan was about 13% per year in US dollars for a 12

year maturity, now is about 7,5% for a 15 year. The high levels of refinancing shown in the high levels of prepayments and the need to maintain high levels of solvency have veered banks into looking for securitization of mortgage-backed securities as a way to accelerate profits.

Nacional Financiera Boliviana (NAFIBO ST) is a Bolivian securitization agency, a sort of a local Fannie Mae, which has implemented the first securitizations of assets and future cash flows in Bolivia. Although mortgages have not been yet packaged into mortgage-backed securities, it is only a question of time. Mauricio Nájera, Senior Structurer at NAFIBO ST says that there are five financial institutions in talks with NAFIBO ST towards a securitization of assets.

Bolivian banks have perceived the following as clear advantages for securitizasing mortgages: (i) For every $100 of mortgages, they received instantly on average about $107 in cash. This impacts the banks bottom line reversing losses and previsions (ii) Even if they sell their mortgages, they keep their customers and received an additional 0.20% management fee on the loan balances for administrating the securitisized assets (iii) They reduce default and interest rate risk of the securitisized loans (iv) They can better match the maturity of their assets and liabilities (v) In Bolivia, securitization is accompanied with important tax deductions that generate important savings.

Additionally, the Bolivian government has enacted important legislation in to stimulate mortgage origination and meet an ever-growing demand of housing at the middle and lower income levels. The governments housing program has created a Housing Trust with a monthly deposit of about $2 million that is deducted from the paycheck of every worker in the country. This trust will cover the 20% down payment of first time homeowners and will provide to the financial system 20-year loans in bolivianos. Likewise, banks must pass these loans to the public creating a primary mortgage market that it is destined to securitization as a final goal.