Moody's warns of the risks faced by banks in Central America in the context of a rising trend in interest rates and dollarization of their loan portfolios.
Friday, September 16, 2016
From a report by Moody's:
Mexico, September 14, 2016 -- Banks in Central America face rising asset risks as interest rates look set to rise in the region, pushing up debt service costs for borrowers, according to a report from Moody's Investors Service.
Domestic lending rates will likely climb as credit demand continues to outpace deposit growth. Interest rates will also be sensitive to potentially tighter US monetary policy in 2017, given the region's high dollarization.
"El Salvador and Panama have fully dollarized economies, meaning that tighter US monetary policy would have a direct impact on these banking system," said Georges Hatcherian, an Analyst at Moody's.
As well as making the region sensitive to US monetary policy, the high dollarization in Central America increases the risk of currency mismatches. In Costa Rica, half of total loans are denominated in foreign currency, and at least 60% of those are granted to local-currency earners. In Guatemala, foreign currency lending accounts for about 40% of total loans, and some 40% of these are extended to local-currency earners.
However, problem loans will likely rise only gradually from the currently low base thanks to continued robust economic growth. Further, higher asset risks will be in part mitigated by good loan loss reserve and profitability buffers, according to the report "Banks Central America - Asset risks rise amid tightening funding conditions." The region's average ratio of non-performing loans to gross loans was a low 1.5% as of June 2016, and remained well below the Latin American average of about 3%.
A pull-out of global banks amidst general de-risking and money laundering concerns that is adding to payment and funding risks, is among other challenges facing banks in Central America. Heightened risk aversion has led international banks to reduce their correspondent banking ties to the region, making it harder for some small banks to process cross-border payments. On the other hand, bank regulators have started to tighten their compliance frameworks, which, coupled with banks' good liquidity buffers should somewhat help mitigate external refinancing risks.
The governments of Costa Rica and Nicaragua will face greater challenges in obtaining financing in external markets, because of the lowering of their risk ratings by international agencies.
Arguing that Costa Rica reflects consistently large fiscal deficits, short-term financing needs because of a strong repayment schedule and budget financing constraints, Fitch Ratings reported on January 15 that the country's long-term foreign currency issuer default rating was downgraded from BB to B+.
Fitch Ratings predicts headwinds and higher risks for banks in Central American countries in 2016, resulting in lower credit growth.
From a report by Fitch Ratings Central America:
Headwind: Central American Banking systems face greater risks in 2016. A slowdown in growth of gross domestic product (GDP) in the region and, consequently, lower credit growth is anticipated.
The Financial Superintendency plans to increase reserve requirements for banks that lend in dollars to companies that do not generate revenue in that currency.
As a measure to prevent the growth of dollar loans to individuals and companies that do not generate income in this currency, the Superintendent of Financial Institutions (SUGEF) said it plans to raise reserve requirements for financial institutions and banks in order to address payments in arrears by debtors. Currently the requirement is 0.5% of the balance due.
Fitch Ratings reported that the risks to regional banks during the current crisis are growing and represent a major challenge for 2009.
The combination of reduced credit expansion, fund restrictions and increasing loan provisions have limited the profits of most banks and it is expected for these factors to continue to pressure the results in the coming months.
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