Costa Rica: Incomers incite fight for clients

As foreign players enter the market, how much competition is healthy for Costa Rica’s banks?

The entrance of an élite of foreign banks in Costa Rica is sending shockwaves through the system. The good news is that it is spurring all banks to undertake a root-and-branch change, leading to a wider array of more targeted products, better service and more impartial, longer-term lending. The danger is that banks enter an imprudent fight for market share at any cost as they tussle over clients. To throw further uncertainty into the mix, the highly dollarised country is gradually changing to a new, more flexible currency regime.

Costa Rica’s banking system has moved quickly from a highly fragmented industry dominated by family and by state-owned banks to a concentrated system, where private banks are owned largely by foreigners. Bankers agree that the market was ripe for consolidation and, from a bird’s eye view at least, competition is welcome.

“We’re happy to have Citigroup, General Electric (GE) and Scotia[bank], and their investment in the country. They bring with them know-how, investment and knowledge of markets. There is nothing better than competition – the biggest beneficiary is the customer,” says Alberto Dent, former finance minister, and chairman of the National Council for the Supervision of the Financial System (CONASSIF), the super-regulator that oversees the banking system, financial markets and pensions and their respective regulators.

Regulators anticipate improvements in corporate governance, with stronger internal and risk controls, in everything from credit and Treasury to operational systems. That should start in foreign banks and ripple across the industry and regulators believe that the process has already started. In the past couple of years and especially in the past 12 months, internal controls and risk management have grown in sophistication, according to Oscar Rodríguez, head of the Superintendence of Financial Institutions (SUGEF), one of the regulators that falls under the umbrella of CONASSIF.

It is possible that more change will come, says Mr Rodríguez. That might include the entry of one of the Latin-oriented Spanish banks or domestic consolidation: Banco de Costa Rica has had an interest in Banco Crédito Agricola de Cartago and has tried to convince political constituencies that the two would be stronger as a merged entity, so far without success.

New rivalries

Even without further new entrants, the arrival of foreigners has stirred the market. “Everyone is waiting to see the reaction of the major banks to this new competition. We’re still just testing the water,” says Mr Rodríguez.

It was something that the market had long been anticipating, but the speed with which the acquisitions took place was faster than foreseen, bankers admit.

State-owned banks believe that they have a couple of advantages that will help them to fend off foreign competition. One is a truly national footprint. Banco Nacional de Costa Rica has 150 branches in the country and 4500 staff, for example, a similar amount to its rival Banco de Costa Rica. HSBC, on the other hand, had 38 branches and Scotiabank 42 in late 2007.

The other advantage is time. The state-owned banks are working on wooing customers before the foreign-owned banks have bedded down their Costa Rican operations. For now, foreign players are concentrating on consolidating systems, and are bogged down with staffing, training and branding issues, says Bernardo Alfaro, an assistant general manager at state-owned Banco Nacional de Costa Rica.

“Finishing acquisitions and establishing data processing platforms is quite an endeavour,” agrees Mr Rodríguez. And Mr Alfaro says: “We have a one- to two-year framework while the other banks are suffering a lot. After that, they will start to compete more directly.”

Teething troubles

Guessing how long individual foreign banks will focus primarily on internal issues is difficult. Any teething troubles will probably be more severe for Citigroup and Scotiabank because they already had a presence in Costa Rica and need to sort out staff duplications, according to Gerardo Ulloa, general manager at Banco BCT in San José. “Scotia is going through labour pains. It is merging two very different operations and has moved to a brand new platform,” he says.

GE’s and HSBC’s acquisitions have been easier because they had no prior presence in the country, says Mr Ulloa. BAC has continued to be a significant competitor and because HSBC does not have its hands tied with eradicating duplications between two bank franchises, it is likely to emerge as the next, real foreign competitor.

Scotiabank says its approach to integration sets it apart from other international banks in the region. “We ensure the participation of local staff throughout the process, which allows us to focus on managing the business, while rationalising operations and realising synergies,” the bank says in a written statement to The Banker.

In its Costa Rican acquisition, Scotiabank implemented a disciplined integration process and developed a strategy based on the strengths of both banks. “Early on, we identified key employees and put in place a retention programme. At the same time, we initiated a customer retention programme that included personal calls, letters and visits from senior staff. This has kept our clients abreast of the integration process, ensuring we continue to meet their needs throughout the transition,” it says. The proof is that “we have continued to grow throughout the process. Net income for the first three quarters of 2007 was $34m, up 30% on the comparable period last year”.

Local banks say that they are ramping up, building customer service and consolidating their head start. “We reduced margins, and our spreads and have been expanding our loan portfolio as fast as possible while retaining prudent and conservative policies. That way, we don’t leave space for private and foreign banks,” says Mr Alfaro.

Customer service

In this newly changed landscape, one of the key battlefields is customer service, particularly retail. Queues at the headquarters of Banco Nacional, where Mr Alfaro is based, snake around in the vast and gloomy lobby, with waiting times of hours. Bankers admit that customers get short shrift and that standards vary greatly from branch to branch.

According to Mario Castillo, general manager at Banca Promérica, a private, full-service bank, priorities at his institution to improve service include a new platform for authorising credit cards, anti-fraud measures, opening an offsite processing centre, spending more on systems and hardware, and an improvement in internal and external communications. The bank is also turning to international best practices to figure out what it does well and what it does less well. Managers are ranking each sector, giving a desired and actual rating and seeking to close the gap, he says.

Banco Nacional has created a new quality management department to develop training programmes and has hired an outside firm to perform surveys to evaluate the bank in each service and in each branch. Where performance is below par, branches, departments and individuals will have their bonuses reduced or cut altogether, says Mr Alfaro.

The bank is also working on standardising processes in its six regions. Mr Alfaro admits that customers entering a branch in the north of the country are evaluated and treated differently than in the south, for example in terms of documentation requirements and lending criteria. That needs to end, he says. “We want to implement best practices in this area.”

There are pitfalls in developing customer interfaces, Mr Alfaro acknowledges ruefully. Banco Nacional launched a website that he proudly claims to be the best in the market. Unfortunately, it may be putting the cart before the horse: only 10% to 15% of customers are active users of the online service. Not only does the bank need to learn but it is “equally a question of educating customers”, he says.

Lending trends

If customer service is likely to be a key distinguishing feature of banks, the most competitive area is set to be lending. For corporate loans, Mr Castillo says he thinks that foreign banks are weighed down with the apparatus of all large banks, including slow and bureaucratic decision making. That is particularly damaging in the area of corporate credit, where a committee is usually involved, based in the headquarter country. They work to international standards, for example, often requiring a big five audit before they will approve a loan.

“Try to explain that to a mid-sized company in central America. It won’t wash,” says Mr Castillo.

Consumer credit markets including mortgages and cars are already highly competitive, says Mr Ulloa. Mortgages of 30 years at 7.5% in dollars and 10% in colones, which is close to the inflation rate, already exist and loan-to-value ratios have risen and tenors increased to as much as seven-year financing periods, he adds. There is a risk that, as banks fight for share in a market that is already relatively well served, albeit growing fast, they will enter a damaging race to the bottom.

Credit dangers

Thanks to the US and its home-grown credit crisis, which has its roots in overly generous credit, this is an acutely sensitive issue for regulators. Mr Dent clearly recognises the dangers: “We have advised all banks that we don’t look kindly at them taking 100% of the risk of a loan as we don’t think it is safe. If there is a glut of lending, we could look to increase reserve requirements on banks.” This is a threat that he has already discussed with banks.

In mortgage loans, for example, Mr Dent reasons that prudent lending should mean banks not taking on more than 65% to 70% of the market value of a property. Some banks are flouting what he sees as common sense. “We have seen 100% and even 110%.”

Mr Dent has been to talk to senior bankers at the organisations involved. “Bankers don’t like being told what to do – but regulations allow us to impose reserve requirements.” The government will not bail out banks if they fail, and for state banks losses will be counted against equity, he says.

To compete in the loans market, domestic banks need deep pockets. Mr Ulloa admits that funding is the main challenge for BCT. “We need to build market share in deposits, which will not be easy. We are going after sight deposits and trying to build new strengths. We are getting customers who want more personalised service and are peeling off from the foreign banks,” he says.

There are three sources of funding: the deposit base, other banks and capital markets, and BCT is looking at all of them. The bank issued $5m of bonds with a 5% 12-month and 5.15% 18-month tranche, which Mr Ulloa says it will repeat if conditions are right.

At the high end of corporate lending, debt markets should take off, especially for non-multinationals, according to Julius Landell-Mills, managing director at boutique adviser and private equity house Mesoamérica. For the most part, transactions are carried out without recourse to equity funds.

Nevertheless, the initial public offering of Panama’s national airline, Copa, on the New York Stock Exchange was an indication of what is possible. It was a runaway success, says Mr Landell-Mills. “Given the buzz surrounding emerging markets, we’re likely to see more Copas in the next few years,” he predicts, although he admits that it is unlikely that they will use markets in the region, which are mostly confined to listing fixed-income instruments. The London and Madrid stock exchanges are more likely destinations, he says.

Credit growth

The market for credit is likely to grow fast, in part because predictions for Costa Rica’s economy are rosy. Gross domestic product (GDP) growth came in at 8.2% in 2006, is estimated to have been 6% in 2007 and is expected to be 5% this year. Tourism and manufacturing have been particularly robust.

There are good reasons for continued optimism. The tight ‘yes’ vote in the October 7 referendum on a free-trade agreement with the US, the Dominican Republic-Central America Free Trade Agreement, promises to attract more foreign direct investment. That should bring in more businesses of the likes of giant Intel, which invested $300m in 1996. And, since Costa Rica established relations with China in 2005, Chinese companies have been using Costa Rica as an export base to circumvent US restrictions.

Rapid growth, together with earlier distortions in the economy, particularly the foreign exchange regime, had been stoking inflation, and the central bank seemed to be losing control when it hit 13.8% in 2005. That triggered the alarm and led the central bank to shift from a crawling peg to a crawling band regime. It is likely that the currency will be allowed to float against the dollar in the longer term. The strategy worked and inflation went down to 11.5% in 2006 with an estimate of 9.1% for 2007 and 6.9% for this year, according to the International Monetary Fund.

Currency risk

There is one major difficulty: a large proportion of bank loans, especially to colon-earning consumers, is in US dollars. Transition to a floating regime would expose them to greater currency risks and authorities are frantically looking to mitigate that. One solution that is being worked on is the development of derivatives, including in the foreign exchange market, to reduce banks’ exposure to currency fluctuations, according to Mr Dent. Initially, the contracts will go out no further than three or six months to test the water. If that is successful, the time span will be extended.

“We need to be very careful. We are looking at how to organise and regulate the market and make it an even playing field,” says Mr Dent.

Exactly when the currency might float is not clear, largely thanks to the accelerating slide of the dollar in international markets. The colon has moved relentlessly up against the greenback and continually bumps against its ceiling. In response, the central bank allowed the currency to appreciate by more than 3% overnight last November, but the currency has stubbornly continued to trade at the ceiling. Its strength is starting to hurt the most dynamic sectors of the economy, particularly tourism and exporters.

If appreciation is allowed to accelerate – and many see a level of 450 to 470 (compared to current levels of 500) against the dollar as at least a good possibility by the end of this year – it would start to squeeze margins hard. It would have an adverse effect on the export segment, says Mr Rodríguez. And if the dollar’s slide turns to a rout, unwinding of the crawling rate regime will be more difficult to navigate.


General Electric Co bought a 49.9% share in BAC San José for $500m in June 2005. The bank has branches in Panama, Guatemala, Honduras, El Salvador, Costa Rica and Nicaragua. Its credit card unit, Credomatic, is the biggest card issuer in the region.

Toronto-based Scotiabank bought Banco Interfin in 2006 for $294m. It is the country’s largest
private bank.

HSBC bought Panama’s Banistmo for $1.8bn, making it the largest retail financial institution in the region. Banistmo has operations in Costa Rica, El Salvador, Honduras, Nicaragua and Panama.

Citigroup acquired El Salvador’s Grupo Cuscatlán and its operations in Guatemala, Costa Rica, Honduras and Panama for $1.5bn in late 2006. Citi also bought Grupo Financeiro Uno, which has a presence in Guatemala, El Salvador, Honduras, Nicaragua, Costa Rica and Panama.

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