EMERGING MARKETS. Banking regulation: Standard deviation

Decades of regulatory conservatism mean that Latin American banks should have few problems hitting Basel III requirements. But credit risks remain


Latin bankers say they are generally well prepared for the capital provisions of Basel III and its precursor Basel II, thanks to already high capital requirements from regulators and conservative allocation of assets.

But the challenges will come as regulators seek to interpret and create rules to meet Basel III’s new definitions of tier-one capital and stress and counter-cyclical provisions in markets, in a region where tier-one capital definitions are hazy.

In bank systems dominated by foreign financial institutions, there is also the unknown effect of how home-market regulators will treat them and the trickle down effect tightening at home might have on Latin subsidiaries. But the growing consensus is that any ill effects should be mitigated by local regulations, growing deposit bases and improving capital markets.

Most of the region’s banks already meet the overall capital ratio provisions of Basel III, which builds on its predecessor with requirements for more capital overall and redefines and increases demands for core capital.

The current average level of total Brazilian capital is close to 18% against Basel III’s 8% minimum. Local regulators can be tough too. Brazil, for example, already has a minimum total capital requirement of 11%. That is substantially higher even when the conservation buffer of 2.5% and anti-cyclical buffers, which can go up to 2.5%, are added.

That allowed Brazil’s central bank enough confidence to announce in February that it would anticipate some provisions in Basel III, noting that the country’s banks “were in a more comfortable position than most of their international equivalents”. Basel III will be implemented internationally between 2013 and 2019.

Most banks in the region have high levels of tier-one capital, says Neil Shearing, economist at Capital Economics. Even Colombia, which has the lowest tier-one capital ratio in the region, is at 10.1%, while Argentina, the region’s highest, is at 17.1%, with Brazil and Mexico in the middle at 14.5% and 15.3% respectively, he says. Anything less than 10% should set off a red light.

Those high ratios reflect the conservative reaction by regulators to the crises of the 1980s and 1990s, which led them to clamp down on bank activity with high reserve requirements and conservative prudential standards. That helps explain in large part the continent’s quick recovery from the 2008 crisis. “Global banks are more affected by Basel II and III than Latin banks,” says Celina Vansetti-Hutchins, senior bank analyst at Moody’s in New York.

Indeed, with the rules biting harder in other areas of the world, the Basel requirements are likely to lead to more bank debt and equity capital markets deals out of the region. Latin banks might even turn the tables and expand overseas.

One concern is how international banks with Latin subsidiaries will react to Basel III, and whether subsidiaries could suffer as a result of tougher provisions at home. Mexico’s central bank chief Agustín Carstens has publically aired this concern, although recognizing that local laws mean subsidiaries are at least well capitalized locally. Mexico is dominated by foreign banks including Spain’s BBVA, Citi from the US and the UK’s HSBC.

Another cause for concern is rapid credit growth in a number of countries. That is setting off warning signals, especially in Brazil, Colombia, Peru and Chile, but even there most banks are seeing a rapid rise in deposits to cover loans.


Clues as to approaches to Basel III can be gauged from the implementation of Basel II, a process that is nearly complete. Regulators chose very different ways to implement Basel II, with much depending on the number of credit ratings, says Andrew Powell, principal adviser at the IDB in Washington.

Sophisticated Chile is implementing the standardized approach, relying on external credit ratings, while Brazil has gone for the opposite tack, opting for the simplified standardized approach, which includes operational risk but doesn’t differentiate between credit risks, notes Powell. Other countries are cobbling together Basel I with elements of Basel II.

In part, there’s no obvious route because Basel regulations are more apt for European and US banks. “Basel II doesn’t fit Latin America very well as the standardized approach requires lots of capital markets ratings; if your country doesn’t have many rated companies, you won’t get very far,” he says.

Even in markets with ratings there is the problem of reliability. “Rating agencies know some things better than others and tend to rate firms better than they do countries and structured products,” says Powell.

Moreover, the Advanced Measurement Approach (AMA), where banks use an internal rating, sits uneasily with many Latin regulators, who are active overseers and tend to have rule-based regimes where banks are not given much discretion.

If the calibration of Basel II and decisions surrounding the AMA are difficult for Latin banks where ratings are sparse, Basel III promises to be dauntingly complex. In much of Latin America, even core tier-one hasn’t been well defined yet, he says.


The effect of Basel II on Latin banks will be limited, and international banks have been anticipating the transition, says Powell. However, given that credit markets are growing fast and from a low base, provisions probably need to be more aggressive for Latin America. Credit in Peru has been growing at close to 42% yearly, with Colombia at 20% and Brazil 15%, says Shearing. Colombia and Peru are starting to flash warning lights, he believes.

Brazilian banks, however, say they are keeping a careful eye on the situation. Bradesco is conservatively managed, and moreover very high spreads would compensate for a marked increase in defaults, says Odair Afonso Rebelato, general manager at Bradesco. Individual credit loans remain small, diffusing risk, he says.

But Powell points out that the sub-prime crisis was provoked by small loans. And Vansetti-Hutchins says it is difficult to understand consumer behaviour because so much of the lending is to first-time borrowers. “In an environment where inflation is rising and you have consumers with low income and education levels, extra caution needs to be exercised,” she says.

Although default rates are low in Latin America, patchy data from credit bureaux make life difficult. Privately, many risk managers at banks say that a lot of employees are more interested in chasing growth than controlling credit.

In recent months central banks have tightened up on lending, and some foreign banks are pulling back. Vansetti-Hutchins recalls that in a recent conversation with a foreign bank in Latin America, the manager said that he couldn’t see himself approving any credit in Brazil, thanks to the consumer debt dynamics and aggressive competition. Small and mid-sized banks in Brazil and those that have a business plan reliant on credit should be particularly carefully monitored, she says.

Other countries are leaning too far the other way, stifling growth. In Mexico, the banks are overly cautious, says Vansetti-Hutchins. “There’s tons of capital parked in Mexico, and small companies are starved of credit,” she says.

Mexican banks’ largest exposure continues to be to state companies such as oil giant Pemex and state-owned electric companies, along with sub-sovereign states and municipalities, and the very largest companies such as Cemex.


As the picture for lending is uneven across the region, liquidity management is only a concern for banks in those countries where credit is expanding fast, and even there only among small banks or those heavily exposed to the credit markets.

Today, much of the additional capital for lending is coming from a boom in opening bank accounts and collecting deposits. However, at the same time, capital markets are playing an ever-more important role in funding.

The situation is completely different to 2008 when governments tried different measurements to stimulate bank lending. Indeed, a problem now is to wean banks off government help schemes.

Today, the macro picture for capital flows into the region is very positive, allowing banks to raise funds easily. There were a large number of bond issues from Brazilian banks last year. Many smaller banks that had never tapped international bond markets did so, including non-investment grade issuers. “Brazil is flavour of the month, and international investors appear not to be very discriminating,” says Vansetti-Hutchins. Moody’s rated some R$27 billion in Brazilian bank bond issues last year.

Over time, easy access to capital markets could build up problems for banks, particularly with smaller niche players, Powell believes. Small banks can, in particular, get hooked on one funding source, which may dry up in the long run, and the bull run could be building up vulnerabilities which become apparent only when the cycle changes, he says.

Almost no Mexican banks are funded through international debt markets. Given their deep conservatism, they can use local markets such as pension funds and asset managers if they need to, but most have more funding than they need, Vansetti-Hutchins says.

The situation is so benign that foreign banks are turning to Latin markets for a larger portion of overall fund raising. Credit ratings are improving in the region, and Chile is increasingly being used as a bulwark against weakening ratings in Europe.

Banks are also looking to expand, including using local capital markets as a financing route.

Santander has been showing the way, acquiring Bank of America’s 24.9% stake in Santander’s Mexican unit for $2.5 billion last June. The bank has been raising funds through debt markets, particularly in highly rated Chile, and via equity markets. Last year, Santander sold shares representing 1.9% of the share capital of Banco Santander Chile, for $291 million.

That followed an IPO in Brazil in 2009 when Santander raised some $8 billion. The bank is looking at requesting regulatory permission for a float in Argentina – this is part of a global strategy that includes taking its UK unit public.

The deepening of Latin capital markets, the growth in deposits and hawkish local regulators are likely to temper concerns about rampant credit growth. But it remains to be seen how banks headquartered outside the region cope with the new regulations in their home markets.

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