More than one year into the COVID-19 pandemic, capitalization and liquidity levels across a range of Latin American banks remain almost intact, and in some cases have actually strengthened.
Key capitalization metrics such as the common equity Tier 1 ratio — which compares banks' capital against their risk-weighted assets — have gone up for nearly all major banks in the region, S&P Global Market Intelligence data shows. Liquidity ratios, which reflect how much cash and other assets the bank has to cover expected losses, show levels that are at least at 100% of potential loan defaults.
Judging from banks' balance sheets, the COVID-19 crisis has not taken as deep a toll as many initially expected. But although the current buffers could guarantee a safe passage through the remainder of the crisis, analysts argue they will not last forever, nor should they if banks want to regain profitability that was given up during the pandemic.
"Liquidity is always the best insurance that [a bank] can have," Alfredo Calvo, a bank director with S&P Global Ratings, said. "But from a profitability perspective, the bank does not need to be so liquid [and] it is not in their interest to operate with buffers so high."
Calvo explained that the rate the bank earns on investments from its cash is far less profitable than the one it makes on a traditional loan. Although high buffers can help lenders wade through complex situations in solid standing, they are not desirable as a long-term strategy.
Furthermore, as most Latin American banks do not expect they will require further rounds of extraordinary COVID-19-related provisions, buffers will gradually decrease in the next two years.
Bulked up metrics
At the onset of the pandemic, savers fled to quality to offset the high degree of uncertainty and put their money in banks. Investors withdrew from their investments, and families in places such as Colombia shifted their funding from non-banking financial institutions toward traditional lenders.
In addition to that, corporates exhausted available credit lines in order to seize cash. But that funding did not leave the bank for investments or expenditures, but rather remained as an emergency expense for companies and individuals to have at their disposal.
Deposits shot up in many banks in Latin America, but the same cannot be said for credit.
"Capitalization strength is a consequence of a smaller size of the loan portfolio," Edgar Cruz, the head of credit research at Mexico-based BBVA Bancomer SA, told Market Intelligence. "Capital expenditure programs have been reduced in many industries [and] deposits have been increasing as the general public and companies saved resources rather than spend them."
As a result, capitalization levels stand way above minimum regulatory frameworks. Under Basel III, CET1 must be at least 4.5% of risk-weighted assets, while Tier 1 capital must be at least 6%, and total capital must be at least 8.0%. The total minimum capital adequacy ratio of both tiers, also including the capital conservation buffer, is 10.5%.
Mexican banks lead the way in terms of capital ratios. Grupo Financiero Banorte SAB de CV, Banco Santander México S.A. Institución de Banca Múltiple Grupo Financiero Santa, Grupo Financiero BBVA Bancomer SA de CV and Grupo Financiero Citibanamex S. A. de C. V. are among the five institutions with higher CET1 capital ratios. At a system level, Mexican banks had a ratio of 15.6% by the end of 2020, the highest among large Latin American economies.
For Calvo, the downward performance of credit in Mexico explains why capitalization figures stand out. "Loan growth contracted 2% in nominal terms, whereas deposits grew by more than 10%."
"There was no demand for credit, people were very cautious and that is why liquidity shot up," he added.
The performance is in stark contrast with other countries such as Brazil, in which government support and guarantees had banks in a more comfortable position to lend. In addition, flexibility measures provided by regulators enabled commercial banks to handle risk assets in a different way. As a result, credit grew at a 15% pace in 2020.
Change in strategy ahead
But despite the current high levels of capital buffers, analysts expect a gradual fallback to pre-pandemic levels.
"Banks will face important challenges to maintain current buffers...but it's not necessary for them to maintain such high levels," Calvo noted. In that sense, the analyst highlighted the importance of greater credit demand and the improvement in economic conditions for banks to channel those funds.
For 2021, S&P Global Ratings is forecasting a 5% growth in loans for the region. As long as demand for credit remains moderate, banks will likely continue to have excess liquidity.
At the same time, as the economy reopens, the deposit bonanza that took place in early 2020 could begin to wane as customers make use of their savings in different ways.
"This is not a long-term strategy [for banks]," Cruz said. "It could affect capital return ratios. We expect that as the economy recovers during next two to three years, capital ratios would return to pre-pandemic levels."