Banks that co-operate with Venezuelas government can make good profits, but some fear a total takeover of the banking system is the true game plan.
Posters of the stout, stern president Hugo Chávez and his favourite slogans dot Caracas, with the stirring Motherland! Socialism or death, a particular favourite of his. A key part of the drive to implement 21st-century socialism entails overhauling the economy, focusing on building communal rather than capitalist enterprises.
In December, 2006, Mr Chávez consolidated power and announced he is working on a new constitution. In these circumstances, all bets are off and risk has become impossible for companies and banks to price. For individual banks, building a long-term, sustainable business is all but impossible. Short-term profitability comes down to one key question. How much are you prepared to deal with the government? Those that cultivate cosy relations find rich pickings. Those that do not see business stagnate.
The government is getting bolder in implementing its drive towards socialism, says Robert Bottome, editor of financial paper VenEconomy. The president now has the authority to enact decrees in a wide range of government activities for 18 months, he says. The new constitution, which was slated to be unveiled in August but has been postponed, perhaps to December, is causing consternation as so few of its provisions have been leaked.
Businessman Arturo Sarmiento, who is setting up a media company headquartered in Caracas, believes fears are overdone and that there will be room for private business in the new Venezuela. Indian and Chinese companies are prospecting in Venezuela for joint venture oil opportunities, he points out.
Whichever version is right, Mr Chávezs tendency to aggregate power and his reluctance to reveal plans for the constitution are generating uncertainty and a collapse of investments, except in the oil industry, which lubricates the Venezuelan economy. Oil price rises account for the 10.3% GDP growth recorded in 2006. They say that the best business in the world is a well-run oil company. The second best business is a badly run oil company, quips Miguel Octavio, executive director of Caracas-based private client bank bbo.
Cash from oil has pumped liquidity into the system at unmanageable rates. Money supply growth was up by 69% in 2006 and 47% in 2005, according to José Grasso Vecchio, director at Softline Consultores. This has led to official inflation of 17% in 2006. Many bankers say that official figures are manipulated. The government has been cutting value added tax to bring down inflation and routinely fixes the basket of goods that it uses to measure inflation.
Oscar García Mendoza, president of Banco Venezolano de Crédito (BVC), says inflation on some goods is 40%. Imports have exploded as the domestic economy stagnates. Last year, the government declared that imports reached $34bn and they are estimated to hit $45bn this year, representing some 85% of oil exports, says Mr García.
Government responses to its inflation headache have included fixing the exchange rate and tampering with prices on an ever-wider range of staples. The government is ratcheting up the pressure on what it calls hoaders and speculators and will continue to issue dollar-denominated debt that locals can buy in bolivares to take local currency out of circulation. It may also start to reverse its policy of low interest rates. Real interest rates were a negative 8.96% on an annualised basis in June on bank deposits, according to VenEconomy. Saving deposit rates, for example, are just 10.10%. An increase in rates may be unpopular but may prove irresistible to bring down inflation and stem the flight to the greenback.
Given uncertainties over policy, inflation, interest and exchange rates, you might think bankers should be somewhat gloomy. Yet the profitability of Venezuelas banking sector is rising rapidly. Profits were 1800bn bolivares (626m) in 2003 but nearly doubled to 3300bn bolivares in 2006, according to Mr Grasso. The financial sector has grown; it represented 20% of GDP in 2000, now it is 40%, notes Francisco Faraco, president of bank research group Francisco Faraco y Associados in Caracas. Future uncertainty explains why for many banks it is important to make hay while the sun shines.
And there is one particularly gilt-edged opportunity for banks: government business. The range of government activities and its growing role in the economy means opportunities for those that curry its favour are legion. The government directs its huge deposit base to preferred banks. It also has a raft of commissions at its disposal as well as providing opportunities to exploit the difference between the official and parallel rate for bolivares.
Most Venezuelan banks have some relationship with the government but the banks seen as being particularly close are Banco Occidental del Descuento, Banco Caroni, Bancoro and Banco Canarias. Bolívar Banco, Banco Confederado and BanPro, all slated to merge, are also favoured. Foreign banks have mostly shied away from accepting government business and giant Banesco is involved but not so deeply, bankers say.
The government deposit business is huge and growing. At the end of 2006, government deposits represented 18.1% of total bank deposits of 115,000bn bolivares. Unsurprisingly, these are directed at banks with which the government has a good relationship.
Recent government bond issues have proved a much bigger boon. So far this year, the government has issued a little over $10bn. The highlight was a $7.5bn PDVSA, the state petroleum company, deal issued in April. The bonds are dollar-denominated but can be bought with bolivares. The government says that it issued the debt to democratise share ownership of PDVSA, raise capital and take liquidity out of the system.
The successful placement of the deal, which was heavily over-subscribed, and further bond deals show investors willingness to take Venezuelan risk, says one banker close to the government. Critics counter that the deal was snapped up by speculators, multinationals seeking to repatriate profits and locals desperate for dollars and say that the deal merely endorses capital flight.
The bonds were sold at an implied rate of 2800 bolivares to the dollar when the parallel exchange rate was 3400 bolivares, says Mr Octavio. That netted buyers a tidy 20% overnight profit, he points out. Profitability for the banks was enhanced through commissions from the government and buyers. Mr García estimates that banks made over $2bn on the transaction, more than the total profits from the banking sector in 2004, 2005 and 2006 combined.
Since then, the parallel rate has ballooned. In early August the dollar was fetching 4500 bolivares. The official rate has been maintained at 2150. That means that future bond deals placed by the government open up ever more lucrative arbitrage opportunities for banks willing to take them. Further Bonds of the South deals, in which Venezuela buys bonds issued by strategic partners, are slated to come to market after a second successful placement of some $1.5bn in Argentine debt in February. Ecuador, Bolivia and further Argentine deals are all likely, with a similar structure to the PDVSA deal.
A banker close to the government points out that Venezuela offers reasonable financing to countries that have no or prohibitively expensive access to markets. They are in a win-win situation, he believes. Critics say that the deals enrich the privileged few and represent a poor use of government money.
In addition to government work, huge demand for consumer loans has pushed up profitability. The six biggest banks control 70% of deposits and 72% of credit, says Mr Grasso. Liquidity has given consumers confidence to borrow and as real interest rates are negative, depositing money does not make sense. For banks, the business is attractive as rates on lending to consumers are capped at a much more enticing interest rate at just under 29% than government directed lending.
Banks also need to invest cash, which has proved more and more of a headache as yields on government bonds have come down from 20% in the past four years to about 7% now, points out Mr Octavio. Consumer lending grew 62.6% last year in nominal terms (or 39% taking into account inflation), reaching 69,800bn bolivares, according to data from Banco Mercantil. Most of the loans are being used for assets and are financing home construction and acquisition, car purchases and credit card purchases.
For now, published delinquency rates remain below 1%, says Mr Grasso, who generally credits the figures that banks publish. With strong economic conditions, he has little fear of a credit crunch. Banks are flying blind, however. The law is stacked in favour of borrowers and credit bureau Sicri stopped providing information on debtors in December 2005, says Mr García. Banks consumer credit portfolios remain unseasoned and of course typically non-performance increases with maturity of the loan, points out Mr Farapo.
A big increase in interest rates could be devastating as most of the lending is floating-rate and typically rates re-set every 30 days. Finally, ever-tighter restrictions on lending rates will continue to erode profit margins in this area.
Despite the many dangers for consumer lending, banks are lobbying for another decrease in capital adequacy ratios. The government has shown its willingness to indulge banks in this area before. These have already been watered down substantially, from 10% to 8%. Banks are now lobbying for 6%. That moves Venezuela firmly in the opposite direction of Basel II capital adequacy rules and would allow them to gain further exposure to the highly unstable consumer lending market.
The future of Venezuelas 58 banks and financial institutions is precarious. They already need to negotiate the turbulence caused by distortions in the economy and an outlook of uncertainty over future government policy. The only certainty is that, if it continues, the current government will take more control over normal profit-making activities.
The government already intervenes heavily. For now, the most important measure is the law that mandates directed lending. By year-end, banks will need to lend a minimum of 37% of portfolios to four government-favoured sectors: agriculture (21%), housing (10%), tourism (3%) and microfinance (3%). These figures are being progressively increased over the year, with agriculture going up from 15% and tourism from 1.5%. Profits on these loans are low.
The government is also moving to control the profitability of consumer lending. Much consumer lending is already capped, points out Mr Farapo, who expects the government to cut rates and apply them more universally.
Pessimists reason that implementing the fully socialist system that Mr Chávez promises is incompatible with a capitalist banking system. For them, it is only a question of time before the banking system is brought under state control. At what price the government would buy banks is anyones guess, but Mr Farapo points to recently nationalised telephone company CANTV as a worrying sign of government stinginess.
The government froze the price at which CANTV offered services for two and a half years, which helped slash the share price. Mr Farapo concedes that the government paid close to the share price (it paid $17.80 per share for stock quoted at some $19), but says the franchise was damaged and a private company would have paid twice the price.
Those that are more optimistic see Mr Chávez as a pragmatist who is moving to implement socialism slowly and wants to keep a healthy and vibrant banking system that will play a key role in funding social programmes. Provided banks play along with the government, they will be safe, they reason.
Both sides agree that the government will tighten up banking regulations. The most likely next steps will include upping the amount of directed lending to at least 40%. Mr Chávez has repeatedly warned banks that he would take special measures if the banking system does not comply, says Mr Vecchio, adding that: Most of the Venezuelan banking system works with the government. The government hasnt had to act on its threats.
Mr Farapo believes that the government will also soon go ahead with long-awaited plans to appoint one or two board members in each bank.
The government is also working to beef up state-owned banks, which currently represent some 9% of the banking system. That could slash profitability in basic banking services. The government created subsidised shopping for basic goods through Mercal, initially an informal distribution mechanism and now an established supermarket chain, notes Rafael Muñoz, professor of macroeconomics at Andrés Bello Catholic University. It undercuts regular supermarkets.
The development of state-controlled Banco El Tesoro and to a lesser extent Banfoandes has not yet been successful, bankers agree. El Tesoro does not have the regional branch network to act as a universal bank, although the government is now working to make sure that it has at least one branch in each state. That may lead to a change of tactic to accelerate the process. The government might buy a bank with a national footprint, says Mr Vecchio. It has bought a medical insurer to cover government workers, he notes. If so, it could offer subsidised services to consumers that would drain the business of private banks.
Banks are having to ride the rapids in Venezuela. Many suspect that the ride could get a lot more frightening, although the grounds for an economic meltdown are not in place while oil remains so highly valued. It is likely that interest rates will need to go up slightly and that should dampen enthusiasm for consumer credit. It is possible that a devaluation of the currency might prove necessary as uncertainty on economic policy encourages speculators. It is also possible that the country will be paralysed by new strikes or other demonstrations when the new constitution is announced.
Stay in line
For banks, it is very likely that tougher restrictions will come, slowly strangling normal business lines. For those that want to gauge what happens to those that do not toe the line, they can cast an eye over BVC. The conservative bank says it has refused to have any dealings with the government. We prefer to have a clean business and see it shrink than to have to deal with this government, Mr García says.
BVC pays the price. The share price is in free-fall with market capitalisation declining from $600m in 1994 to under $100m now. The government is increasingly pressuring banks that do not fully co-operate, Mr García adds. BVC has to deal with constant requests from the government for documentation, frequently at very short notice. That is ironic from a government that publishes so little reliable information itself. In the meantime, a few banks make good money by arbitraging the distortions in the economy.
Mr García has an apocalyptic vision of the future of his countrys economy. Were sitting in a huge volcano. We just dont know which weakness will cause the final explosion, he says. Finally, all banks will be victims of this government.
On a mission: president Hugo Chávez is getting bolder in implementing his drive for socialism.