Key Takeaways
- Chile's two largest private banks reported return on equity (ROE) of more than 20% in the second quarter after a sluggish first-quarter inflation.
- S&P Global Ratings expects Chilean banks to partly recover from the slow start of the year as inflation converges closer to the central bank's 3% target, while domestic and global easing monetary policies take effect.
- However, a prolonged period of trade-related uncertainties, global economy's cooling, and the slow progress in the Chilean government's reform agenda may continue to undermine domestic business confidence and economic growth.
- Retail loans fuel lending growth in Chile, despite choppy corporate lending activity. Large banks continue to deploy resources in innovative strategies to attract individuals and small businesses.
After disappointing financial results in the first quarter of the year, Chile's two largest banks were able to turn around in the following quarter. As of June 2019, the banking system's average ROE was 16% year to date (YTD) up from 13.5% as of the end of March 2019, although it still slightly below the same period of 2018. The recovery stemmed from the higher quarterly inflation that caused the Unidad de Fomento (UF; the currency adjusted to inflation) appreciate 1.2%. This followed a plateaued inflation rate in the first three months of the year, which reduced banks' revenues for that period. Chilean banks have historically maintained long position in UF that influences the system's profitability metrics over the economic cycle.
Chart 1
The Chilean central bank reversed its course during its June monetary policy meeting with a surprising 50 basis-point cut to 2.5% amid softening economy, low inflation, and the expectations that the U.S. Federal Reserve will cut its interest rate. In addition, the central bank argued that the country's potential output is higher due to the impact of large immigration flows into Chile in recent years. The government estimates that about 1.3 million foreigners currently live in Chile, more than 6% of its total population. Under vigorous expansionary monetary stimulus, prices should rise to levels closer to the central bank's target, which will banks help maintain profitability in the next two quarters.
However, lower-than-expected economic growth could undermine business volumes. After a rebound in credit demand during 2018, corporate demand for credit has fluctuated in the first half of this year in response to the uncertain global economy and contained copper prices. On the other hand, Chile's large banks have expanded lending to the retail and small and medium enterprise (SME) sectors, which generate higher margins and associated non-interest revenues in fees and transactions.
Higher Inflation Bolsters NIMs
Profitability of the two largest private banks benefitted mostly from higher NIMs in the second quarter of 2019. Banco de Chile posted a 23.8% ROE for the period, returning its YTD metric to 18.2%, which is within its financial guidance of 18%-20%. The higher origination of retail loans also strengthened margins. This, combined with fee growth of above 20% compared to the same period last year, more than compensated for the bank's rising operating expenses and provisions. Moreover, Banco Santander Chile posted a 21.8% ROE, which boosted the YTD number to 19.4%. The bank continues to improve its asset quality metrics and post strong corporate client treasury revenues that offset lower fee income. Despite the increasing expenses in digital banking and innovation, we expect both banks' efficiency ratios to return to historical levels.
Chart 2
Retail Banking Is Attracting More Attention
Retail lending continues to drive the industry's growth amid bumpy corporate demand for credit and low interest rates. Commercial lending slowed down in the first two quarters of the year because of the country's subdued investment pace and soft business confidence. On the other hand, the individual and SME borrowers continue to benefit from the expansionary monetary policy and have been in the center of large banks' commercial and digital strategies. These lenders are striving to retain customers as they continue to move away from cash and checks toward electronic payments. Competition in mortgage and consumer lending is heating up, generating CLP3.5 billion and about CLP1.4 billion in fees and commissions for the financial system in the first half of 2019. Competition among Chilean banks has also risen through the following services: mobile banking, preapproved loans, debit/credit card fees and transactions, deposits, investments, ATMs, insurance, among others.
Chart 3
Profitability Will Depend On Inflation Prospects And Retail Lending
We expect the banking industry's NIMs to continue recovering for the remainder of the year because of the likely higher inflation following Chile's recent loosening of its monetary policy. Under such a scenario, we expect profitability to continue rising and large banks to deliver expected results despite the weaker economy. We estimate loans to grow 8%-9% on nominal basis mostly thanks to robust pace in retail loans, while corporate lending awaits for higher investments in Chile. Large banks will focus on expanding lending to individuals and SMEs in the next few years. However, the banking consolidation in the past five years (with each of the top six banks controlling more than 10% of the market) should intensify competition.
This report does not constitute a rating action.
| Primary Credit Analyst: | Rafael Janequine, Sao Paulo (55) 11-3039-9786; rafael.janequine@spglobal.com |
| Secondary Contact: | Ivana L Recalde, Buenos Aires (54) 114-891-2127; ivana.recalde@spglobal.com |
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