Banks To Face Further Pressure From Government Regulation

BMI View: Recently introduced financial sector regulation in Ecuador will put pressure on private banks to extend credit to new segments of the economy. While this could bolster the financial sector's growth, we see potential for deterioration in banks' asset quality, elevating systemic risks.

Ecuador's banking sector will continue to struggle in the coming quarters due to an unfavourable regulatory environment under President Rafael Correa ( see 'Banking Sector To Underperform Its Growth Potential', September 5 2013). This view was reinforced by legislation introduced to the Ecuadorean national assembly by the Correa administration in late June. The bill seeks to consolidate control of monetary policy and all regulatory authority over the banking sector in the hands of a new committee, 'The Political Board for Monetary and Financial Regulation', comprised of members of the executive branch. Most significantly, the bill gives the committee authority to determine how privately-held banks allocate credit. Correa's Alianza PAIS political party controls 100 out of 137 seats in the national assembly, and we expect the bill to pass within the next several weeks.

Potential Benefits, As Credit Extended To New Industries

Banking Sector Still Relatively Undeveloped
Ecuador - Private Bank Metrics

BMI View: Recently introduced financial sector regulation in Ecuador will put pressure on private banks to extend credit to new segments of the economy. While this could bolster the financial sector's growth, we see potential for deterioration in banks' asset quality, elevating systemic risks.

Ecuador's banking sector will continue to struggle in the coming quarters due to an unfavourable regulatory environment under President Rafael Correa ( see 'Banking Sector To Underperform Its Growth Potential', September 5 2013). This view was reinforced by legislation introduced to the Ecuadorean national assembly by the Correa administration in late June. The bill seeks to consolidate control of monetary policy and all regulatory authority over the banking sector in the hands of a new committee, 'The Political Board for Monetary and Financial Regulation', comprised of members of the executive branch. Most significantly, the bill gives the committee authority to determine how privately-held banks allocate credit. Correa's Alianza PAIS political party controls 100 out of 137 seats in the national assembly, and we expect the bill to pass within the next several weeks.

Potential Benefits, As Credit Extended To New Industries

The bill marks a new phase of the government's efforts address the country's persistent trade and current account deficits. If done prudently, this could see credit extended to new industries, bolstering Ecuador's banking sector, which has significant growth potential owing to low rates of penetration. As we have previously noted, the government has directed public financial institutions, including Corporación Financiera Nacional and Banco del Pacífico, to allocate less credit to import-intensive sectors in recent months, and towards non-oil sectors with greater export potential ( see 'Strengthening Imports To Drive Trade Deficit', May 28). Once the new financial regulation is enacted, the government will be able to direct private banks' credit allocation towards similar aims. This should benefit sectors such as petrochemicals and renewable energy, as well as businesses looking to expand Ecuador's industrial capacity. For example, the government has cited the coffee sector as an example of an industry where the country should aim to become self-sufficient. Currently, coffee growers must import heavy machinery from abroad to facilitate production. 

Banking Sector Still Relatively Undeveloped
Ecuador - Private Bank Metrics

But Banking Sector Risks Broadly On The Rise

However, we believe that the risk of deterioration in banks' asset quality is likely to offset the potential gains for the aforementioned industries, particularly given that private banks in Ecuador are already under pressure from a string of legislation in recent years that have squeezed profits ( see chart below). Indeed, key pieces laws enacted since Correa assumed office in 2007 include the imposition of a tax on capital leaving Ecuador, a requirement that banks hold 60.0% of their liquid assets domestically, the setting of maximum interest rates and ATM fees, and restrictions on what types of assets banks are allowed to hold.

Profits Squeezed By Government Regulation
Ecuador - Private Bank Profits, USDmn (LHS) & % chg y-o-y (RHS)

We are sceptical that the new committee will be able to effectively oversee private banks' credit allocation without elevating the risk of deterioration in banks' loan portfolios. We expect that the government is likely to put policy aims, including extending credit to lower and middle income citizens, at the forefront of deciding how to disperse loans. This could see loan default rates continue to head higher, elevating systemic risk in the financial sector. Non-performing loan (NPL) rates have already started to rise in recent months, particularly among microenterprises, a segment to which the government will seek to extend additional credit. Non-performing loans to microenterprises account for over 6.0% of total loans to that credit segment.  With profit margins narrowing, a rise in NPLs could put further pressure on banks' balance sheets, calling into question the sectors stability. As such, we will be watching default rates closely in the coming months for further indication as to the health of Ecuador's banking sector.

Default Rates Rising In Key Sectors
Ecuador - Non-Performing Loans By Type, % of Total

Oil To Remain Central To The Economy

While the government's goal of allocating credit towards new industries is intended to help diversify Ecuador's economy away from a reliance on the oil sector, we believe that it will remain the major engine of economic growth for the foreseeable future. Indeed, at the same as the new financial regulation is being debated, the government is moving ahead with its plan to drill in a previously off-limits section of the Amazon that could boost the country's oil production by around 20.0% during the latter stages of our 10-year forecast period ( see 'Amazon Offering Upside Risks To Production', April 22).

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Related sectors of this article: Economy, Economic Policy
Geography: Ecuador
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