Major Factors

Rationale

S&P Global Ratings classifies the banking sector in Peru (foreign currency: BBB+/Stable/A-2; local currency: A-/Stable/A-2) in group '5' under its Banking Industry Country Risk Assessment (BICRA). Other countries in BICRA group '5' include Italy, Mexico, the Philippines, Hungary, Iceland, Panama, and Bermuda (see chart 1).

Our bank criteria use our BICRA economic and industry risk scores to determine a bank's anchor, the starting point in assigning an issuer credit rating. The anchor for banks operating only in Peru is 'bbb-'.

Peru's economic risk reflects its low per capita GDP (about $6,000) and relatively high exposure to cyclical sectors such as SMEs and microlending. We forecast GDP to grow 11% in 2021, mostly explained by a very large rebound from the 11% GDP decline in 2020. Due to political instability, investors will likely remain more cautious, which will contribute to slower GDP growth in 2022 of 3.5%. We expect credit to expand at low single digits in the next two years and asset quality to weaken in 2021 due to the large informal economy and low income levels when loan moratoriums and support packages are lifted, and start recovering in 2022.

The industry risk for banks operating in Peru benefits from a solid regulatory framework, with ample supervisory coverage and periodic risk-based supervision under a highly professional regulator. Both the central bank and Superintendencia de Banca y Seguros (SBS)--which regulates banks and insurance companies--are very active. Moreover, Peru has implemented Basel III standards tailored for the domestic financial system. Peruvian banks have enjoyed strong profitability, although this has weakened during the pandemic, but we expect gradual recovery. We also believe the country's financial system has healthy capital metrics and a diversified funding mix with a significant share of deposits from loyal customers, as well as strong government support to provide liquidity if needed. We don't expect the recent law on interest rate caps to significantly affect banks' profitability, but additional measures like this could weaken the system's competitive dynamics.

Chart 1

Economic And Industry Risk Trends

Peru's economic risk trend is negative. Despite the government's substantial stimulus package, Peru's economy was one of the hardest hit in the region by COVID-19. We believe the risk of mounting credit losses in Peru could dent banks' profitability and capitalization. We expect credit losses to moderate in 2021 because banks generated most loan loss provisions in 2020. However, nonperforming assets (NPAs) to total loans will continue increasing this year as loans moratoriums and support packages are lifted.

In our view, Peru's industry risk trend is stable. Profitability will gradually recover from the sharp drop in 2020 as margins recover, fee income picks up, and provisioning charges moderate, but bottom-line profits won't return to levels similar to those prior to the pandemic until 2022. Moreover, we expect the Peruvian banking's funding structure to remain healthy and for its regulator and central bank to continue introducing regulation in a proactive matter as needed, while shifting away from the measures introduced to contain the impact of the pandemic on the financial system. Peru's Congress approved in March 2021 a law that imposed ceilings on banks' interest rates. Although we believe this measure won't significantly hit profitability, additional measures like this could weaken the system's competitive dynamics and result in a weaker industry risk assessment.

Economic Risk  |  6

Economic resilience: Per capita GDP of about $6,000 in 2020

Economic structure and stability.  Peru's economy was one of the hardest hit in the region by COVID-19. We forecast GDP to grow 11.0% in 2021, up from 10.2% in our previous projection, due to a better-than-expected first-quarter result--we anticipated a contraction, but GDP was flat. However, most of the growth this year is explained by a very high carry-over of over 14%, following the 11% GDP decline in 2020, because Peru had one of the strictest lockdowns in the region, including the critical mining sector.

Macroeconomic policy flexibility.  We expect the fiscal deficit to gradually narrow as the economy recovers and as pandemic-related spending scales back. The decrease in revenue due to the economic contraction and the increases in the government's current spending from emergency measures were the main reasons behind the 8.7% GDP deficit in 2020. Amid the pandemic, the government approved a temporary suspension of the fiscal rules (including the debt limit of 30% of GDP). The latter will be reviewed by the new administration, along with the multi-year macroeconomic framework that delineates economic and fiscal policy objectives for the next five years.

To finance the larger deficit spending, the government reallocated some budget lines, used government assets (including the Fiscal Stabilization Fund that as of December 2020 had US$ 1.0 billion of the US$5.5 billion--or 2.5% of GDP--in 2019), and increased debt issuance in the global and local capital markets. We expect continued access to markets and use of government assets to cover financing gaps.

In March 2021, Peru issued global bonds in U.S. dollars and euros for almost US$5 billion at favorable conditions and with maturities of 10, 20, and 30 years. In addition, we think the government has good relationships with various multilateral institutions and access to credit lines. In May 2020, the IMF approved a two-year US$11 billion flexible credit line arrangement (FCL) for Peru. The FCL is designed for crisis prevention, and the government intends to use the line as a precautionary measure.

Political risk.  In recent years, Peru has had multiple events of political volatility, including a highly polarized runoff presidential election in June, which anti-establishment candidate Pedro Castillo won. Governability risks are likely to continue given the fragmentation in Congress and the persistent tensions between the executive and legislative powers. Investors will likely remain more cautious toward the country until there is more visibility on the new administration's policies. This will slow GDP growth in 2022, which we project at 3.5%.

Table 1

Economic imbalances: Credit growth to decline after strong growth driven by government-guaranteed loans

We believe Peru remains in an expansionary phase. Lending growth has been strong in 2020, at 12.6%, as a result of the guaranteed program offered by the government to SMEs and because of the higher credit demand from corporates as they boosted liquidity to prepare for difficult conditions due to the social distancing measures.

We consider the structure of the government guarantees offer through the "Reactiva Peru" program to be supportive for the banking sector because banks receive the funding from the central bank. If the borrorwer doesn't repay the loans, the loss is distributed based on the guaranteed percentage, which is generally 90%, meaning the bank will only have to repay the 10% of the loss and the rest is repaid by the fund that backs the guarantee and is managed by COFIDE. As of April 2021, the total amount of guaranteed loans reached PEN52 billion; 16% of total loans. The loans have a length of 36 months with a grace period of 12 months.

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Private sector credit growth.  We expect lending growth in 2021 to be much lower than the previous year, at low single digits. This is because of the absence of the extraordinary measures from the government and banks' lower risk appetites, given the uncertain conditions stemming from the recovery prospects and political instability. We expect lending growth this year to stem from retail lending as opposed to corporate lending, because we anticipate less demand from the corporate sector and expect retail expenditures to recover as social distancing restrictions are lifted.

Chart 2

Real estate prices.  Residential home prices have remained relatively stable over the past four years, so we aren't concerned about a buildup of economic imbalances driven by the property market.

Mortgage lending growth has been sustainable in recent years, growing 8.3% in 2019 and 4.3% in 2020 on a year-on-year basis. This segment represents only about 7.7% of GDP.

Equity prices.  Equity prices have been volatile in Peru in the past five years, and the SP/BVL General Peru Index (Lima's stock exchange index) increased 2% in 2020 and 7% in 2019. However, relative volatility in Peru's stock market isn't a major concern for our BICRA assessment, because the banking sector has very limited exposure to the stock market. Peruvian banks traditionally invest in government debt, and due to overall conservative investment practices, we don't expect this trend to change.

Current account and external debt position.  Our base case assumes that Peru's external profile will remain resilient. We project slight deficits in the current account, with higher exports from improving global demand and commodity prices, offset by increased imports as the local economy recovers. We expect foreign direct investment inflows to partly cover the current account deficits. In addition, Peru's high international reserves–-which increased by almost US$7 billion in 2020 to US$72 billion-–provide a buffer to address external shocks.

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Credit risk in the economy: Large informal economy and fragile conditions for SMEs are key risks for banks

Private-sector debt capacity and leverage.  The local regulator has allowed banks to offer loan moratoriums, similar to other countries around the world, for borrowers facing financial hardship because of COVID-19 without making the loans as delinquent. At the peak, in May 2020, loan moratoriums reached 30% for the banking sector and 34% for the entire banking system. However, as of April 2021, this ratio decreased to 14% for the banking system and 16% for the financial system. The bulk of the loan moratoriums were directed to mortgages, consumers, small businesses and microcredits.

In our view, loan moratoriums and government-guaranteed loans will mitigate the risk of defaults. However, a large informal economy and difficult conditions for SMEs will pressure loan portfolios as government relief measures are withdrawn. The economic rebound we expect this year is a crucial factor that could help cushion asset quality deterioration. We expect NPAs of 3.6%-4.0% by the end of 2021 and then moderating to 3.5%-3.9% in 2022. As of the end of 2020, private-sector credit represented about 53% of GDP, higher than historical levels due to the pickup in government-guaranteed loans while GDP contracted. We expect this ratio to decrease in the next two years to 47%-48%.

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Lending and underwriting standards.  Our view of the Peruvian financial system's lending and underwriting standards is moderated by its still significant exposure to foreign currency lending and to the cyclical SME sector, which raises credit risk. Microcredit and loans to SMEs represented about 29% of total credit as of May 2021 for the banking system. The share of dollar-denominated loans has fallen consistently in the past decade, thanks to the central bank's measures, and due to the government-guaranteed loans that were offered in local currency. As of May 2021, the banking system's dollar-denominated loans to total loans was 23.5%.

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Payment culture and rule of law.  Peru's payment culture and rule of law limit our credit risk assessment. We believe Peru's political institutions and judicial framework still have shortcomings: corruption scandals are common, and the public distrusts the justice system.

According to the World Bank's Worldwide Governance Indicator, Peru is in the 33rd percentile for Rule of Law and the 37th percentile for Control of Corruption indicators as of 2019 (the latest information available). Additionally, according to the Doing Business Index, Peru ranks 90th (out of 190 countries) in resolving insolvency, as of May 2019. Insolvency in Peru takes an average of 3.1 years to resolve, and the recovery rate is 31%.

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Base-Case Credit Losses

We expect the Peruvian financial system's credit losses, which peaked at 4.8% in 2020, to slightly drop to 4.2% in 2021 and 3.5% in 2022.

Our credit loss estimate for Peru in the next two years incorporates the following assumptions:

• GDP growth of 11.0% in 2021 and 3.5% in 2022;
• Lower unemployment rate of about 12.7% in 2021 and 9.8% in 2022;
• Relatively low inflation of 2.4% in 2021 and 2.3% in 2022, on average; and
• NPAs to be 3.6%-4.0% by the end of 2021 and moderate to 3.5%-3.9% in 2022.

Industry Risk  |  3

Institutional framework: Proactive regulations and supervision provide significant support

Banking regulation and supervision.  We assess Peru's banking regulation and supervision as intermediate, indicating our view that SBS adequately regulates and supervises the industry. SBS amply covers the industry: it supervises deposit-taking and non-deposit-taking entities, insurance companies, and pension funds. In general, the regulatory framework aligns with international standards, and we think SBS very actively issues new regulations to prevent potential risks. For instance, in the past few years, the regulator introduced a number of measures that helped significantly reduce the dollarization of the loan portfolio.

SBS has implemented the Basel III framework adapted for the Peruvian financial system. The implementation had three steps: introducing buffers, creating new liquidity standards, and improving capital quality. The buffers capture economic cycles; systemic risks; and other risks such as single-name, geographic, and economic sector concentrations. SBS is now working on Pillar 3 of the Basel requirements: leverage reporting and implementing the net stable funding ratio (NSFR). SBS hasn't revised its regulatory capital definition because this change would require amending the Financial Services Law.

With respect to capital quality, SBS introduced regulations that:

• Revise minimum maturity hybrids considered Tier 1 capital to 60 years from 30;
• Eliminate step-ups; and
• Change loss-absorption capacity (conversion of write-offs if Tier 1 capital or risk-weighted assets [RWAs] fall below 5.125%).

Furthermore, because the current legal framework doesn't allow banks to apply new deductions toward regulatory capital requirements, authorities increased the risk weight on intangibles to up to 1,000% from 100% and on deferred tax assets (DTAs) up to 1,000% from 20% to achieve the deduction effect.

Regulatory track record.  We believe Peru's regulatory track record is strong. In our view, the institutions that together oversee the industry (SBS, the Ministry of Finance, and the central bank [BCRP]) proactively identify problems at an early stage and act quickly to remedy them (please see the regulation and supervision section). We think that these institutions have significant power to take corrective actions.

They efficiently handled the impact of Russia's 1998 default and the global financial crisis in 2008-2009. During Russia's default, the authorities adopted measures that included intervening in foreign exchange markets to prevent the Peruvian sol's sharp depreciation and corresponding severe effects on banks' balance sheets. The government provided foreign-currency liquidity lines, reduced reserve requirements, bought credit portfolios from banks, and created programs to foster banks' mergers and reorganizations with the participation of new investors.

During the 2008-2009 financial crisis, Peru's economy was on a stronger footing, international reserves were larger, and the banks held greater liquidity and solvency positions. Nonetheless, authorities promptly introduced preventative measures, including lower reserve requirements and longer terms for liquidity facilities. They also worked to contain exchange rate volatility.

In response to the COVID-19 pandemic and economic impact of the social distancing, the SBS and central bank have taken timely measures to limit the disruption to the financial system including:

• Removing the liquidity buffer, counter-cyclical capital buffer, and relief in capital charges for renegotiated loans. However, at the same time the SBS urged banks to reduce dividend payments on 2019 revenues.
• Allowing banks to renegotiate existing loans that were not already overdue without marking them as nonperforming for up to 90 days, with no requirement to raise provisions.
• The central bank reduced the interest rate to a record low of 0.25%, reduced reserve requirements for deposits, and had additional liquidity injection instruments such as repurchase agreements (repos) against reserve funds, currency substitution repos, credit portfolio repos, foreign currency repos, and a package of PEN30 billion guaranteed by the finance ministry to support businesses.

Governance and transparency.  In our view, the Peruvian banking sector's corporate governance is adequate. We think it has conservative governance standards, given that boards of directors have majority independent members. The regulator discloses a satisfactory amount of financial information, with high frequency, timeliness, and solid reporting standards.

Competitive dynamics: Banks have a moderate risk appetite and a fairly stable market share

Risk appetite.  We believe Peruvian banks' risk appetite is moderate, given the low share of innovative and complex products and the absence of sophisticated securitization, both of which indicate limited risk-shared lending. The system's overall profitability has significantly weakened due to the increase in loan loss provisions, reaching return on equity (ROE) of 3.8% from 18.0% in December 2019. We expect profitability to gradually improve as margins recover, fee income picks up, and provisioning charges moderate, but bottom-line profits won't return to pre-pandemic levels until 2022.

In March 2021, Peru's Congress approved a law that allows the central bank to impose caps on banks' interest rates on a semiannual basis. The central bank established the new maximum interest rate at 83.4% per year, for new consumer credits, low-amount consumer loans (less than or equal to two tax units), and for new credits for micro and small enterprises. This maximum interest rate is equivalent to twice the average interest rate on consumer loans in the financial system. The law also prohibits the capitalization of interest and the collection of penalties or other commission or expense in case of non-payment or late payment of the credit. Although this measure will negatively affect banks' profitability, we expect the impact to be manageable for major banks because the interest rate is relatively high, but additional measures like this could weaken the competitive dynamics for the system. In addition, nonbank financial institutions' (NBFIs') could be more affected, especially those focused on the lower-income segment and micro credit.

Industry stability.  We assess industry stability as at least moderately stable for various reasons. First, banks' market shares have remained fairly stable for the past five years. The financial system in Peru consists of 15 private commercial banks, four government-owned banks, and 38 NBFIs, all of which are regulated. The three largest banks--Banco de Credito del Peru (BBB+/Negative/A-2), Banco BBVA Peru (BBB+/Stable/A-2), and Scotiabank Peru S.A.A. (BBB+/Stable/A-2)--had a joint market share of 76% of total loans as of May 2021, and provide stability to the industry with their financial strength. Finally, the likelihood of new entrants that could alter the competitive dynamic is low because of the difficulty of competing with well-established and large institutions.

Market distortions.  We don't think that the presence of government-owned banks or NBFIs cause market distortions. As of December 2020, government-owned banks represented 1.7% of the system's total loans, with a focus on particular niches like infrastructure, second-floor lending for mortgages to lower-income borrowers, agribusiness, and public-sector workers. SBS supervises and regulates NBFIs, ensuring that they meet the same regulatory requirements as traditional lenders. NBFIs account for less than 10% of total system assets as of April 2021.

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Systemwide funding: Strong economic fundamentals with a stable deposit base, tempered by high dollarization

Core customer deposits.  The Peruvian banking sector's funding mix reflects a stable deposit base, although the still relevant amount of dollar deposits that tends to increase when the local currency weakens, is a risk. As of May 2021, deposits accounted for about 86% of the system's funding, and issued debt--in both local and international markets--represented about 7%. Other types of financial obligations, such as credit lines from international organizations (development banks, multilateral lending agencies, or repos from the BCRP), accounted for 7%.

We consider Peru's core deposit base to be 100% retail, with 50% of that corporate. We've incorporated 50% of BCRP's repos into our analysis since 2014 because they were provided for banks to swap foreign currency deposits and be able to lend in local currency. We view this as a very stable funding source. The share of core customer deposits to loans increased to 84% in 2020 but we expect it to return to historical levels of about 75% to 80% in the next two years. We believe this level of customer deposits is manageable, given the availability of funds in the domestic capital markets and the low share of external funding in the banking system. Exposure to external funding represents only 9.2% of total domestic loans as of the end of 2020 and we expect the share of external funding to remain low.

As of April 2021, the system's dollar-denominated deposits accounted for 35.7%, up from 33.1% in February 2020. The increase was mainly due to the political instability from the presidential election. In addition, every time the Peruvian nuevo sol weakens, households and institutional investors tend to shift to dollars to prevent losses on their savings. We consider this as a weakness for banks' funding profiles.

Domestic debt-capital markets.  In our view, Peru's debt capital market is narrow and shallow. Private-sector issuances represented 13.5% of the GDP as of December 2020. The private sector has very few issuances with long-term maturities. Large Peruvian issuers have been increasingly tapping international markets in the past few years because that allows them to issue debt with longer terms, in larger amounts, and at lower prices, while reducing creditor concentration risk. Furthermore, large domestic institutional investors look for investments abroad because they're more liquid than domestic bonds, given the domestic secondary market's lack of depth.

Government role.  We believe the government has had a large role in providing liquidity to the system in the past, and we believe it will continue providing guarantees and liquidity to support the banking system when needed. In the current difficult economic conditions, Peruvian authorities have used several tools to ensure the system had sufficient liquidity and to support parties affected by social distancing measures (please see the regulatory track record section), as it previously did successfully during the 2008-2009 financial crisis. Furthermore, the BCRP has actively fostered liquidity in local currency to reduce dollarization and to support credit growth, particularly in 2015 and 2016.

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Peer BICRA Scores

Peru has one of the weakest GDP per capitas among its BICRA peers (after the Philippines), limiting its economic resilience. Peruvian banks have lower economic imbalances than those of most BICRA peers, reflecting slower credit growth, the absence of credit or real estate bubbles, and their low exposure to the commercial real estate sector. Peruvian banks have the weakest position compared to peers in terms of credit risk, reflecting the system's high dollarization, exposure to cyclical sectors, and weak payment culture and rule of law. However, Peru has a better industry risk score than some peers because of its strong institutional framework supported by the regulator's solid track record.

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Government Support

In our opinion, the Peruvian government supports its banking system. The government has supported both the entire system (during past crises) and specific entities, and we expect this behavior to continue. In addition, given the system's size, the government has adequate capacity to support it if needed.

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Related Criteria And Research

Related Criteria

• Sovereign Rating Methodology, Dec. 18, 2017
• Banks: Rating Methodology And Assumptions, Nov. 9, 2011
• Banking Industry Country Risk Assessment Methodology And Assumptions, Nov. 9, 2011

Related Research

• Peru 'BBB+/A-2' Foreign Currency Ratings Affirmed; Outlook Remains Stable, May 4, 2020
• Banking Industry Country Risk Assessment Update: April 2020, May 1, 2020