On September 12, Federico Sturzenegger, Governor of the BCRA, gave the closing speech at the 33rd International Financial Marketing Congress, organized by the Argentine Banking Marketing Association (Asociación de Marketing Bancario Argentino, AMBA).
The full speech is as follows:
Thank you very much for this invitation to take part again in the congress. I would like to take this opportunity to make a presentation on how I see the current state of our country’s financial system and its outlook for the future.
As you already know, our financial system is tiny. At the beginning of our administration, deposits were only 15% of GDP and loans scarcely amounted to 12%. We were years behind neighboring countries, such as Peru, where credit is 40% of GDP, Bolivia, where it is 57%, or Brazil, where it totals 66%, let alone Chile, where it is greater than 80% of GDP.
I talked about this problem at last year’s congress, and the reasons why it came about. The main causes were a combination of regulations making it difficult to operate in the financial sector plus a high degree of financial repression. Caps on interest rates, fees and other operating mechanisms meant that the financial system did not reward depositors, who consequently put their savings into other investment vehicles, such as assets abroad or real estate.
Last year I also mentioned what would have happened to someone who had placed ARS1 in a time deposit in the Argentine financial system 35 years ago and had kept renewing it to date. Those of you with a good memory will know that said person would now have less than one and a half cents of their initial peso in terms of purchasing power. Yes, one and a half cents. In other words, they would have lost practically all of their original deposit. Some people say that Argentineans are culturally programmed to save in dollars or property. This is nonsense. People would flee from an investment that wiped out almost 100% of their savings in the long term no matter what country they lived in.
This is the fundamental reason why Argentine savers do not channel their savings through the domestic financial system. As a result, the system is based almost entirely on financial transactions and—in relation to the size of the economy—does not even have a mass of deposits comparable to other countries in Latin America similar to our own. It is clear that our country’s financial sector will only grow and be able to provide broad access to credit again for the first time in years once we change this situation.
Last year I also discussed the pernicious effects of inflation in modifying the strategic vision in banking itself. When no return was paid on deposits in current accounts and savings accounts, banks used to obtain very high margins for each peso they lent. I said then that high inflation had forced the banks into a tight corner where only a few transactions were possible, albeit with a high spread. As a result, the financial system remained very small and the banking system was structurally incapable of contributing to the equitable development of the country. A small system cannot meet our economy’s investment needs for long-term growth.
Lack of credit is in turn a huge barrier to equal opportunities because in this context only those who already have the resources can invest and grow. People with good ideas and business ventures, but without the capital to put them into practice, miss the opportunity to grow because the financing they need is not available. This is one of the strongest arguments for a developed financial system with abundant credit, since it constitutes a very powerful mechanism for providing equal opportunities in any society.
In our Monetary Policy Report last January1 we showed that the Argentine economy had been decapitalizing for the last 26 years. That is, workers in Argentina today have less capital per person than 26 years ago. This is a surprising development, unparalleled throughout the world, and one that partly explains why poverty has fallen from 60% to 10% of the world population since the 1970s, whereas in Argentina it has increased from 5 to 30%.2 It is a surprising development that should prompt us to think deeply. A large part of this backwardness can be explained by the financial sector’s failure to grow.
There are two challenges we face in order to develop the financial sector. One part of the agenda is to bring down inflation. This is potentially the most sensitive issue for banks since the immediate result is to reduce their lending rate with a negative impact on net interest income. This is the part of the agenda that takes banks out of their comfort zone and forces them to look for new horizons. The other part had to do with providing assistance by improving financial regulation and helping to reduce operating costs, the ultimate aim being to promote competition and transparency. Better regulation was undoubtedly crucial for banks to adapt to this new context.
Therefore, my intention today is, first of all, to see how far we have got with this agenda over the last year and whether we have started along the path of growth. Secondly, I would like to analyze the implications of continuing this agenda into the future. In particular, I would like to ask a very specific question: if credit continues to increase at the same rate as in recent months, when will the banks’ current excess liquidity dry up, forcing them to awaken from their lethargy and try to tempt new customers? In other words, when will we see banks grow in earnest?
Taking Stock
When I was here last year, inflation had reached a year-on-year level of 41%. This was the result of tensions we had to overcome resulting from large imbalances created by the previous administration. Today, year-on-year inflation for July has fallen to around 21% according to the data I had when writing this speech and the average annualized rate over the last three months has been 19%. Argentina consequently has the lowest inflation of the past seven years, and the prospects are that it will continue to fall. This process has been achieved without accumulating imbalances or sweeping them under the carpet. On the contrary, the emphasis has been on sustainability.
Of course, this process of disinflation has not been smooth. In the second half of last year, accumulated inflation was 8.9%, an annualized rate of 18.5%. But then it rose above the targeted rate in the February-April quarter of this year. Our appraisal is that this rise was due to an excessive easing of monetary policy at the end of last year and the beginning of this one. That is why the BCRA has tightened the money supply since March 2 by raising the benchmark rate 150 basis points and conducting open market operations to constrain available liquidity. These operations have driven interest rates from the bottom to the top end of the corridor. Together, both measures have resulted in an increase in interest rates on the shortest term LEBAC of 430 basis points while the rate on the longest term LEBAC has risen by 630 basis points.
The policy’s contractionary bias has increased in two ways: firstly, interest rates have risen; and secondly, they have risen during a drop in inflation, which, as I already mentioned, went down to an annualized rate below 20% as from May. As a result, the ex-ante real interest rate, the most direct way to measure the anti-inflationary bias of monetary policy, has practically doubled in recent months.
The persistence of core inflation has convinced us of the need to stand firm on this issue. We believe that it is essential to pursue a tight monetary policy to bring down inflation to the required level. The BCRA will continue with these measures to reach a monthly inflation rate of around 1% by the end of the year. This will keep the economy on a path consistent with next year’s annual inflation target of 10%.
As we have seen, this is one of the BCRA’s main agendas and I believe that the financial system has become aware of the challenge that a drop in inflation poses for it.
Along with this anti-inflationary monetary policy, the BCRA is implementing regulatory changes that will help banks adapt to this new context and provide increasing access to credit.
Most of the changes are intended to save time and work, as well as to give banks the freedom to design and promote new business models. The resources saved can be transferred to depositors in the competitive environment we are aiming to promote. In this way banks will be able to attract deposits and increase their intermediation volumes to compensate for lower individual margins.
For example, we have greatly simplified the branch opening process, which has disappeared as such. What was the point of a regulator making it difficult for the banking system to open branches to serve its customers? The branch authorization process used to take a whole year. Today no administrative procedure is required.
Physical security has moved towards a “risk-based” approach in which each bank decides which measures to adopt in each branch based on its own risk factors. This allows banks to make use of opportunities offered by new technology and improve security for less money. It thus becomes possible to incorporate remote monitoring, own alarm control units, flexible CCTV systems, and electronic safe locks. All these elements help banks save time and money, improve efficiency and enhance the quality of services to consumers. But these are not the only measures we have taken to make life easier for banks and their customers.
We have also authorized the “digital file,” with which registrations and deregistrations can be processed in a paperless environment. Similarly, we have approved the opening of accounts remotely, photo check deposits on mobile banking apps, non-bank ATMs, and off-site location ATMs and a host of other new measures.
The BCRA wants to promote time saving, paperless environments and better use of technology and resources to help banks reduce costs, which inexorably results in lower lending rates and better deposit rates.
Credit
Within the broader context of regulatory innovation and reduced inflation, credit has performed favorably over the last year and we are excited about the prospects of finally being able to witness sustained growth in access to finance. Credit to the private sector has grown 46% since the last time I was here with you 12 months ago. This represents an annualized rate of growth of 61% if we take into account the last four-month period.
There are two specific points about current growth that I would like to highlight. The first of these is mortgage loans. On my last visit, I talked about the advantages that UVA-adjusted loans would bring in terms of access to loans for the general population and, consequently, the overall volume of lending for banks. Today we can talk about a real revolution in the mortgage sector. Credits in UVAs are fully operational and consequently mortgage loans have grown over the last four months at an annualized rate of 92%. There is still a long way to go because we started from a very low level, but the transformation is clearly under way.
The second point I want to emphasize is the question of foreign currency loans because these are closely related to the regulatory innovation I spoke about earlier. Until recently, banks could only lend in foreign currency to exporters because they were considered to be the only companies able to deal with possible rises in the exchange rate that would increase the local currency value of their loans. We have also allowed suppliers of exporters (for example, agricultural producers) access to this type of financing as well as their clients abroad, since, in fact, these agents have the same protection against exchange rate fluctuations. The result has been a 93% growth in foreign currency credit in the last 12 months and 379% since the change of government.
But we have seen not only an increase in the volume of loans, but much longer repayment schedules. This is an expected result in an economy with less uncertainty and lower inflation, in which agents can benefit from greater predictability and longer planning horizons. When I spoke to you last year, the average term of loans in pesos to the private sector was close to 12 months. Today it is almost 30 months.
All in all, the general picture is that between the first half of 2016 and the first half of 2017, credit to the private sector rose by 0.7% of GDP and deposits of the private sector increased by 1.5% of GDP. If we consider deposits and LEBAC in private hands (savings in domestic currency) the increase is 3% of GDP. Credit and deposits as a percentage of GDP are a good measurement of financial sector development, and should be the yardstick by which the success of the BCRA’s development agenda for the banking sector is measured. We are pleased to see that there are already significant increases.
Profitability of the Sector and Competition
I would like to pause here for a moment to talk about another important topic. How has the banking sector fared in terms of profitability in this new context? As regulators we are interested in a solvent financial sector, but we know that the industry faces a profitability challenge. What is the situation right now?
Interest rates have fallen since last year, and this is to be expected in a scenario of falling inflation. The increase in volumes we saw earlier was unable to offset lower interest rates. Both the interest income and interest expenditure of banks declined. As a result, the banks’ profit margin in this period contracted from 12.0% to 10.5% of assets.
These changes have caused a decline in the profitability of the financial sector. The return on assets went from 4.1% in the first seven months of 2016 to 3.1% in the same period of 2017, while the financial return (ROE) went from 33% to 27.2%.
As I said earlier, the regulatory changes introduced by the BCRA were essentially aimed at increasing competition and reducing costs in the system. Let’s look at the results of the last few months in these two areas. The rate of return on services, which is similar to fees charged to customers, fell from 3.8% of assets in the first seven months of 2016 to 3.5% in the same period of 2017. This is a clear example of greater competition. Administrative expenses, on the other hand, fell from 7.7% of net assets in 2016 to 7.1% in 2017. This is an indication of cost improvements.
But I don’t only want to talk about figures. I would also like to mention some specific concerns. Let me start with the issue of greater competition in the sector. Since January 2017, banks have been authorized by the BCRA to provide a return on their customers’ current accounts. It does not seem to be in anybody’s interest for the BCRA to prevent banks from paying for this. Since January, the banks have paid interest on these accounts—a modest rate to begin with but a more aggressive rate later on. At the beginning of September there were more than ARS6,000 million in remunerated current accounts with rates of around 15% per year. It is only natural that this market should develop quickly. There are large elasticities between banks for companies’ current accounts. A company can move its resources easily from one institution to another. So corporate current accounts seem to be the immediate priority for banks competing for deposits. If I were the president of a small or medium-sized bank, I would be much more aggressive in grabbing a share of the market. But I suppose it is just a matter of time until this happens.
I also want to mention another issue—perhaps a more disturbing one. Over the last few years, banks have based their profitability on transactions. This has led to a financial sector with high transaction fees. This situation has been exacerbated by the fact that bank consortia also own the payment networks and the Visa acquiring business. However, a market structure with these characteristics is not appropriate to develop a competitive environment.
This issue has been addressed by the National Commission for the Defense of Competition (Comisión Nacional de Defensa de la Competencia, CNDC). In my opinion, it has done so in a highly professional way, focusing on the common interest. This has already yielded some positive results, such as a commitment by the banks to divest themselves of their equity interests in Prisma, as well as a voluntary agreement to reduce charges.
From the BCRA we will continue to promote competition in the payment systems market. Last year we promoted the use of direct transfers through the Immediate Electronic Payment channel (pago electrónico inmediato, PEI). However, this year several banks took measures to hinder its development, including blocking cards and capping transactions, allegedly to prevent fraud. On the other hand, when some businesses managed to move ahead with implementing PEI (with the help of the Link network), those fears immediately vanished and the same banks that had blocked the service have now begun to offer it, in some cases for fees that are a fifth of those charged by traditional channels.
Obviously, it would be very easy for the BCRA to solve these problems. It could simply impose a reasonable cap for interchange fees and the problem would be at an end. However, we would much rather help develop a competitive market than set maximum prices. But we need the banks to play their part.
For this reason I consider it important that banks understand that the future of the business lies in credit, not in transactions. They should know they have a BCRA that expects this business to grow and believes it is essential if we are to develop a fairer society. The BCRA will do its best to ensure that more credit is made available to a greater number of people in the fastest possible time. At the same time, we believe that payment methods should be efficient and competitive. Business used to lie in transactions but this is not the case anymore nor will it be in the future. It is important to digest this idea so that we can focus our energies on the true sources of social and economic development, and not try to cling to a small monopoly income out of fear—an income it is our responsibility to do away with.
Where does the Movie Go from Here?
Let’s dig a little deeper then into the more constructive agenda of credit growth. The question I am asking now is where the movie goes from here. Over the last four months, real credit to the private sector has been growing at a rate of 2.5% per month, and mortgage loans at 4.1%. But how much is it likely to grow in the coming years? At the end of 2016 mortgage loans in Argentina amounted to less than 1% of GDP, 20 times less than in Chile, 10 times less than in Mexico and 5 times less than in Brazil or Uruguay. We believe it is not unreasonable to suppose that mortgage loans could expand by 4 percentage points of GDP by the end of 2020. Projecting more moderate real growth rates for the remaining components of the banking sector, we believe that total credit to the private sector could expand at a real rate of 1.2% per month. This rate is lower than in the last four months but it would be applied to a growing stock of credit. Once that growth has been defined, we can use our macroeconomic projections and our econometric models to estimate how much deposits there should be in years to come. We can then project the financial system’s balance sheet forward in time, with some simplifying assumptions about required reserves, results and issues of corporate bonds. We will treat the LEBAC holding of the financial institutions as an independent variable.
In this scenario, credit will grow more than deposits and banks will gradually reduce liquidity holdings in LEBAC. If this trend were to continue until the end of 2020, credit to the private sector would end up at 19% of GDP and private sector deposits at 20% of GDP. This would mean a growth of 7 percentage points in terms of loans from the end of 2016 and 4 percentage points in terms of deposits. At the current rate of increase, the size of the financial system would double in terms of credit in the next seven years.
Of course, a process in which credit grows faster than deposits cannot continue indefinitely. At some point, the liquidity of the banks is too low and institutions must go out and take deposits to keep liquidity at a level that is comfortable for them. On the basis of our assumptions, this point will be reached between September 2018 (if banks do not allow liquid assets to fall below 25%) and May 2020 (if they allow them to fall to 10%). However, these dates will be delayed if credit grows at a lower rate.
Estimated moments at which financial institutions would run out of liquidity at different ratios, considering different paths of credit evolution.
If we take an intermediate value as our “critical level” of liquidity, for example 20%, then the moment at which banks are forced to go out and take more deposits would be by June 2019. The main conclusion of this thought experiment is that the banks have ample access to liquidity and this will allow them to sustain strong credit growth for quite a long time without the need for substantial new deposits.
Obviously, the growth potential is much bigger, so maybe the cut-off dates will be a bit sooner. The demand for mortgages is virtually unlimited. For example, if the financial sector were to respond to one million demands for homes in the next few years, it would then have to provide credit to the tune of 1 trillion pesos (the average mortgage loan at present is around 1 million pesos). That figure is equivalent to all the credits granted by the financial sector today. But if the aim is to give loans to 2 million families, obviously we need to double that amount. For the sake of argument I have factored in slightly fewer than half a million loans in the next four years. I think we can say then that today the financial sector has ample liquidity and shows no immediate signs of stress. But credit growth will decide whether these dates are moved forward or not.
Another example of the many unexplored credit niches was seen in the Argenta credit boom for pensioners and people on family allowances, which amounted to over one million borrowers in just over a month. Where were the banks all this time when they neglected a market of one million people?
UVA loans for automobiles are another example of a niche that has always existed and that has suddenly stolen the limelight in a way that no one seemed to have anticipated. This credit line was launched by Banco Provincia and it provided loans to finance the purchase of 23,000 vehicles within just a few months.
These examples force us to reflect on everything that our financial system could offer but still does not. On the “asset” side we can place:
a) long-term foreign currency loans;
b) commercial loans in UVA, generating a flow of interest according to the cash flows of the projects;
c) contingent financial instruments that address risks associated with climate change or commodity prices by packaging financing and risk mitigation in a single instrument;
d) cash flow management instruments to reduce the risks of currency volatility. As you can see, good opportunities for credit supply lie ahead.
I would like to propose just one more thought experiment. This time it is not about the date banks should start looking for deposits, but how much they should raise the interest rate on time deposits to match loan growth to deposit growth. For this, we will use our econometric estimation of the interest rate sensitivity of deposits and we will look for the time deposit rate needed to attract the required deposits. What we find is that once they reach this turning point, banks should raise the interest rate by 1.6 percentage points. Of course it would be 1.6 percentage points in a different context from the current one, with a time deposit rate forecast of 10.7% for June 2019 (excluding the rise).
Estimated increase in the time deposit interest rate matching loan growth to deposit growth on alternative paths of bank credit
I find this result is quite surprising because it shows highly elastic demand for deposits. On an individual level, the elasticity for each bank must be several times larger. So, banks must start preparing for the moment they have to go out and look for funding. On the “liabilities” side this means:
a) boosting savings accounts in UVA and UVI (indexed units of account) to provide a better, longer term savings vehicle, mainly in the retail segment. The BCRA is convinced that there is huge latent demand among Argentineans for a savings instrument that will protect the purchasing power of their savings against inflation and, if possible, pay some interest on top of that. But we still notice a lack of initiative on the part of banks;
b) competition for deposits in current accounts has already begun. What is surprising, however, many banks have still shown little response;
c) more attractive deposit rates for savers. To sum up, the fact that we have not seen strong initiatives in any of these areas confirms our hypothesis that banks still do not feel an urgent need for funding. However, just as it is possible that credit will grow faster or slower than in this thought experiment, it is also possible that some banks will decide to jump the gun and increase their deposit rates earlier. In that way, they will gain market share and be better prepared for change when it does come. Faced with this challenge, I put it to you that this is the best strategy.
In short, we are facing a scenario of profound transformations in which future sources of profitability will surely be very different from those of the past. They will also be much more abundant and sustainable than we are used to. I am convinced that we are prepared to successfully follow this path. And I am pleased to say that, in doing so, we will be helping to create a fairer society, where all Argentineans have more opportunities, where it is easier for all of us to start and complete our projects, and to grow and progress in our lives.
Thank you.
1 See Exhibit 5: “Growth Accounting in Argentina 1980-2016,” Monetary Policy Report, January 2017.
2 Sources: World Bank, INDEC, CEPAL (Altimir, O. (1979): La dimensión de la pobreza en América Latina. Cuaderno de la CEPAL Nº 27. Santiago de Chile: Publicaciones de las Naciones Unidas) and Bourguignon, F. and Morrisson, C. (2002): “Inequality among World Citizens: 1820-1992,“ in The American Economic Review, Vol. 92, Nº 4, pp. 727-744.
