Within the framework of the XXXVII Annual Conference IAEF “From the Present Context to a Sustainable Development Model” which took place on Thursday, September 29, from 4 to 5p.m, Demian Reidel—second Vice Chairman—took part of the panel “Banking System Outlook” together with Guillermo Cerviño—Chairman of Banco Comafi—, Antonio Estrany y Gendre—Vice Chairman Global Banking HSBC Bank Argentina—, and Daniel Tillard—Chairman of Banco de Córdoba—.
“Good afternoon and thank you for inviting me to this Annual Conference at IAEF which focuses on the transition from the present context to a sustainable development model. In this panel, where we will discuss the viewpoint of the banking system on this process, I would like to highlight some structural changes that the Central Bank has implemented and the impact they will have on the future of the Argentine financial system.
Now that Argentina has joined the mainstream at a world level, stabilized her macroeconomic situation and looks forward to attract new investments, the financial system should change thoroughly to play the role of growth trigger. At present, private sector domestic deposits stands for only 15% of GDP, compared with 60% in some of our neighboring countries. The same occurs with credit which is only a 12 % of GDP, while it usually exceeds a 100% in developed countries. These rates are shallow showing that the role of the financial system regarding the transformation of savings into investment has practically come to a halt.
Today, banks in Argentina have merely a transactional role, they may be seen as a large “checkbook”. How have we reached this situation? What different things have we done in comparison with the rest of the region to get such discrepant results? Even more importantly, what can be done to change this course of actions? To increase lending, deposits need to be captured and to do so, it is necessary to determine reasonable rates of return for savings. Which should the rate of return be? Historically, Argentina has gone through several macroeconomic instability periods, so this rate should include a risk premium, an extra return to compensate depositors for risks.
Let’s go back in history and consider how much such premium represented in the recent past. If a depositor, let’s call him John, had invested a hundred pesos in a fixed-term deposit 30 years ago (and as John is clever, let’s suppose he managed to avoid a deposit seizure), how much would he have today? How much extra return has John earned for his money investments in the domestic financial system? Today, John only has a peso and a half. In thirty years, his total return has been -98.5%. Given John’s unfortunate experience, it is not surprising that he decides to deposit the bare minimum amount necessary to pay his bills and keep his business running. In other words, the banking system becomes a purely transactional vehicle. Domestic depositors have systematically faced a negative real interest rate that has undermined the value of savings through time.
One of the most important measures that the Central Bank has taken was to change this train of thought and set a positive real interest rate through its monetary policy tools. As you know, a short time after the exchange clamp was lifted, allowing savers to buy and sell foreign currency freely, the Central Bank changed the way of implementing its monetary policy by replacing the control of money in circulation for fixing the market interest rate. In this way, the Central Bank ceased to control monetary aggregates directly, money in circulation becoming endogenous, that is, directly controlled by the market. Meanwhile, this interest rate became positive in real terms, setting the necessary conditions for deposits growth which is the raw material for domestic credit development.
However, a positive real interest rate is not enough for domestic savings to come back. Broadly speaking, macroeconomic stability is another key element for the development of the domestic financial system, lending and capital markets. Particularly, the Central Bank’s main purpose is monetary stability and, for that reason, it has established a formal regime for inflation targeting. At the beginning of this week, we presented people with this new scheme, which does not only define inflation band targeting but also explains the new operative structure for its implementation. Why have we chosen this system? Although it is a relatively new scheme, firstly adopted by New Zealand in 1990, nearly 30 developed and emerging countries have applied it so far. In Argentina, we expect to get to a 5% inflation target in 2019 with the implementation of this system. For that purpose, we have defined annual bands during the transition period, which range from 12% to 17% in 2017, from 8% to 12% in 2018, and 5% for the years that follow. In addition, we expect a monthly 1.5% inflation intermediate objective for the last quarter this year.
One of the advantages of this plan is that it makes coordination among economic agents easier, as it causes the inflationary process to be more predictable. As mentioned before, by using interest rate as a tool, the Central Bank ceases to control monetary aggregates. This is an advantage given money demand variations (usually hard to estimate) have led to high volatility in interest rate and activity. In the words of John Crow, [SIC]said by Gerald Bouey, former governor of the Bank of Canada: “we didn’t abandon monetary aggregates, they abandoned us”. As part of this comprehensive reform, the Central Bank of Argentina makes known its outlook and the measures it implements at any time in a transparent way. Moreover, it is accountable to society for the fulfilment of its objectives. We expect John feels safer and more protected under these conditions.
As of 2017, our first full year under inflation targeting, inflation expectations have not reached our target band yet. The BCRA Market Expectations Survey (in Spanish, REM) shows an expected inflation general level of 19.8% and an inflation nucleus of 17.9%. This nearly three-percentage point difference between today’s expectation of 19.8% and the maximum level in the 12%-17% band shows that there is still work to do. In our latest report on monetary policy we explain what is being done to do away with this difference and reach our objectives.
Now, I would like to sum up and analyze the compatibility of these two topics: financial system development and struggle against inflation. Fortunately, both objectives require a positive real interest rate, which, as we have already discussed, encourages savings and spurs credit growth. Likewise, it allows the deflation process to be consistent with our targets. Inflation is one of the most regressive taxes which burden mainly falls on people with smaller income. This leads the Central Bank to work relentlessly to reduce inflation in order to achieve a greater development with social equity. However, inflation fall will result in a margin squeeze in the financial sector. The difference between lending rates and funding rates—especially in demand deposit accounts—narrows down when inflation decreases. This implies that banks will have to find new business sources (such as mortgage-backed loans, which are currently inexistent in our country) and to improve productivity and efficiency in all their activities so as to provide the community with a better service.
The Central Bank takes part in this transformation process through the implementation of regulatory changes that seek improving efficiency across the system. Some examples may show this point: the BCRA has allowed electronic deposits of cheques by means of cell phones. This lowers storage costs as well as gives people the chance to quit going to bank branches, thus saving time for both the customer and the bank. We have virtually done away with approval procedures for bank branches, by limiting procedural requirements to a mere notification. Moreover, we have reduced building requirements and stimulated the creation of mobile agencies and automated banking units to achieve a higher financial inclusion in our country’s more remote regions. We have also made flexible the regulations about cash-in-transit companies to minimize transaction costs. The BCRA has fostered the digitalization of the financial system’s files, including the digital opening of accounts to enhance processes.
The issue of regulatory changes in means of payment should be treated individually as for its importance. Let’s focus on the new regulation on the mobile payment platform. This will enable us to make payments to individuals and in shops through mobile units such as cell phones and tablets—real electronic wallets—. These are just a few examples of the major regulatory changes that the BCRA has launched in the last months concerning monetary policy and financial infrastructure. This virtuous circle of macro stability, growth and efficiency improvements in the financial sector will give rise to a more predictable economy with greater credit access and, therefore, a better development of public and private activity.
One of the great advantages of such stability is the possibility of creating a long-term yield curve in pesos. In fact, the government is about to issue a five-year bond with nominal rate in pesos, which means this process has already started. With the creation of this curve, we will have a more liquid and efficient corporate bond market, with a decrease in companies’ funding cost. The BCRA has announced a change to the LEBACs’ auctions scheme so that the short-term curve provides better market return indicators.
Lastly, we are striving to boost the development of derivatives markets. Upon lifting the last foreign exchange restrictions, we have removed the banning of derivatives with foreign institutions. Likewise, we seek to foster the development of derivatives’ domestic market by cooperating with different public sector institutions, such as the National Securities Commission (CNV), bearing in mind that the Law on Capital Markets should be adjusted. The development of a derivatives’ market is essential to efficiently distribute the different risk components of a financial asset. In this way, the holders of each component will be those naturally well-positioned, improving the general risk allocation in economy. For instance, with a fixed versus floating interest rate repos market, an issuer may convert a fixed rate bond into a floating one and vice versa, focusing on getting the best independent price in the most convenient interest rate structure. It is hard to envisage the possibilities of risk coverage that creativity can provide to the economy as to the creation of these markets.
I think that Chief Financial Officers have a leading role in this transformation. You have both the chance and the responsibility to derive benefit from these growing resources in a stability background to assign them efficiently, creating new businesses and making existing businesses improve. In this way, economy will improve and increase employment, and we will all enjoy a more prosperous and fairer society. Thank you.”
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September 29th, 2016