Two key concerns dominate Central America’s banking sector this year – dollarization and consumer lending. The two themes are interlinked – given any significant erosion in capital base, the banking sector’s ability to support the demand for consumer loans may be compromised.
Across the region, the stronger US dollar has also spawned some concerns and widely varied trends within financial products. However, given the generally conservative nature of banks in the region, combined with relatively healthy capitalisation levels, this anticipated USD strength will be unlikely to result in any acute shocks to the overall financial system. An additional consideration is that higher levels of dollarization undermine local central bankers’ ability to implement effective monetary policy, given this is imputed via higher levels of USD within a country’s banking system.
Against the backdrop of lower near-term expected inflation following reduced fuel costs, there is support for further growth in consumption in Central America. Increased use of consumer loans has underpinned this trend, with credit card usage continuing to post solid growth, albeit the market offers consumers few options given the few dominant players.
THE MIGHTY GREENBACK…
The strengthening momentum surrounding the US economic recovery has fuelled further concerns over the level of dollarization in the region’s banking system. Some of this risk is mitigated via self-correction in lower levels of USD denominated loans being issued, with support from regulatory bodies, such as initiatives undertaken in Costa Rica.
In Costa Rica, regulatory bodies have gone one step further, introducing a managed floating rate to replace the currency exchange band. However, regulators are also reviewing policy to impose a higher interest rate to USD-denominated loans to ensure CRC-denominated lending remains competitive, avoiding redenomination issues undermining capitalisation should the dollar continue its upward trajectory. The central bank’s measures also include a possible 15% mandatory cash reserve requirement on medium- and long-term foreign currency funding. In 2014, the SUGEF implemented additional liquidity and capital requirements for foreign-currency assets and more conservative origination standards for loans to non-foreign currency generators. These moves by local regulatory bodies are driven by the fact that Costa Rica is at a particularly high risk of the rising USD given it is one of the most highly dollarized in Latin America, with 47.6% of assets and 50.5% of liabilities dollar denominated as of year-end 2014.
Although dollarization does pose a risk in Honduras, to some degree the risk of rising USD-denominated obligations in the system has self corrected. Given the ongoing devaluation of the Lempira since 2011, the level of USD denominated loans has declined markedly, whilst dollarized deposits in the Honduran banking system have posted significant increases. According to data from the Central Bank of Honduras, the dollarization index for deposits posted an increase of 14.2% over the past two years to January 2015, whilst USD denominated lending plunged -28.8% over the same period. The trend in dollarization has been more pronounced over the past two years in line with the US economic recovery – based on indexed data based at December 2012, as the HNL has devalued against the USD, growth in USD-denominated deposits demonstrate a 0.8 correlation coefficient, with USD-denominated loans demonstrating a -0.8 correlation coefficient. These trends are demonstrated graphically below.
Figure 1. USD-denominated loans and deposits, indexed USDHNL exchange rate (data source: Banco Central de Honduras)
Figure 2. Indexed USD-denominated loans and deposits, indexed USDHNL exchange rate: base December 2012 (data source: Banco Central de Honduras)
The level of USD-denominated liabilities in the Guatemalan banking system is fairly low at 8.1% as at January 2015, with USD denominated assets representing 67.5% of all banking system assets. According to statistics from the Central Bank of Guatemala, the percentage of dollarized deposits has remained fairly stable since December 2009 (high 60s), although USD denominated loans have ranged from 8-12% of total outstanding loans. Legislation recognising the USD as legal tender was only introduced in 2001 in an attempt to attract foreign capital to mitigate risks relating to local currency fluctuations. Given that the GTQ has not experienced periods of hyperinflation or other devaluation, the penetration of USD in the economy remains relatively low in comparison to neighbouring countries.
El Salvador moved towards establishing the USD as the official currency from 2001, replacing the currency peg used previously. Whilst this alleviates issues associated with having multiple currencies within the country’s banking system, there is no scope for establishing monetary policy suitable for the local economy. From a banking sector perspective in El Salvador, the key risk is the acceleration of the US economy versus the local economy, and a lack of fiscal stimulus or other regulatory credit loosening mechanisms to stimulate growth in line with the USD imputed monetary policy.
“HEMOS NACIDO SOLO PARA CONSUMIR…” (Jose Mujica)
Across the region, there has been a solid increase in consumer credit over a very short timeframe, underpinning the growth in consumer spending in the absence of real wage growth. Key takeaways from central bank data and news sources indicate the following findings:
- In Honduras, of the 11 groups issuing credit cards, five control 87.7% of the credit card market. In terms of cards issued, this grew 6.8% in 2014 to 840,768. However, according to Banco Central de Honduras statistics (http://www.bch.hn/emfa.php), aggregate consumer debt (by value) grew 16.4%, with growth in credit card debt growing 23.4% in 2014. Per card, credit card debt grew 15.5%, indicating a greater propensity to spend – the wealthiest 10% of the population accounts for 42% of consumption (2009), and household consumption accounts for some 79.5% of GDP composition by end use (2013).
- In Nicaragua, aggregate consumer lending grew by 24.3% during 2014, with 19.7% growth in credit card debt, with 809,421 cards in circulation (+26.7% year-on-year). According to Banpro Grupo Promerica, between 40-45% of all goods and services are paid for by credit or debit card.
- In Guatemala, according to data from Superintendencia de Bancos (SIB) credit card debt increased 10.7% year-on-year (as at February 2015) to GTQ12.7bn (~USD1.7bn). Data analysis is compromised given the level of disclosure and presentation by the SIB, although credit availability supports consumption which accounts for 84.5% of GDP composition by end use.
Given access to credit issues in the region, combined with the percentage share of consumption dominated by the wealthiest 10% of each country, the increased level of credit card spending suggests a higher level of consumption inequality. Furthermore, increasing household debt in the absence of commensurate growth in household income could bode poorly for longer term consumer lending, particularly should any severe economic shocks occur in Central America. The rampant increased use in credit cards needs to be accompanied by regulation and education to avoid incurring unsustainable levels of household debt.
 “Hemos nacido sólo para consumir y consumir y cuando no podemos, cargamos con la frustración, la pobreza y hasta la automarginación y autoexclusión.” (“We are born only to consume and to consume when we cannot, we are burdened with frustration and poverty to the point of self-marginalisation and self-exclusion”), Jose Mujica, ex-President of Uruguay