Industry Forecast - Banking Sector: Improvement On The Horizon - JUNE 2017

BMI View : Loan growth will accelerate in Chile in the coming quarters on lower interest rates and a broad economic recovery. The sector will remain Latin America's most stable in the years ahead, supported by recovering credit growth and conservative lending practices.

We expect that the Chilean banking sector will bottom in Q117, rising thereafter on higher economic activity and falling interest rates. The Chilean economy has decelerated in recent years on low commodity prices and weak investment, dragging down inflation. The Banco Central de Chile (BCC) has responded by enacting an aggressive rate cutting cycle ( see 'One More Cut To Come In 2017, Before Tightening Begins', March 29), which we expect will keep credit conditions loose through end-2017.

We expect economic growth to accelerate in the coming quarters, bolstering demand for loans. As a result, we forecast total loans to grow 7.5% of GDP in 2017, up from 6.7% in 2016. Loan growth will gradually accelerate thereafter, though a tightening cycle and high banking penetration will limit the sector's growth potential.

Higher Activity Will Boost Loans
Chile - Real GDP & Loan Growth
Source: BCC, SBIF, BMI

Loan Demand To Recover

Credit growth fell to 2.0% y-o-y in January 2017, the lowest level since 2010, due to the broad deceleration in economic activity in recent quarters. Deposit growth has similarly tanked, reaching 1.7% in February 2017, also the lowest point since 2010.

Deposit Growth Bottoming
Chile - Deposit Growth
Source: SBIF, BMI

As the economy slowly recovers on higher copper prices, rising business confidence and the end of one-off headwinds ( see ' Wildfires & Mining Strikes Will Moderate Growth ' , February 28), we expect demand for loans to rise accordingly. This will be bolstered by a low interest rate environment through the rest of the year, which will reduce the cost of borrowing for consumers and businesses.

Future Growth Prospects Less Rosy

While loan growth will pick up in the years ahead, we do not expect the banking sector will return to the robust growth seen in the past two decades. We see interest rates steadily rising in the years ahead, as economic activity recovers and rising oil prices push up inflation. In addition, growth is unlikely to return to its commodity boom highs, given structurally lower prices and production in Chile's copper sector.

Loan Growth To Remain Below Long-Term Average
Chile - Loan Growth
Source: SBIF, BMI

Moreover, Chile's banking sector has relatively limited scope to expand within the country. Client loans have reached 87.0% of GDP as of February 2017, by far the highest among Latin America's major economies. With no large unbanked populations to expand into, the sector's growth potential will be limited.

Much Higher Banking Penetration Than Peers
Latin America- Client Loans, % Of GDP
Note: 2017 forecast; Source: National Sources, BMI

Sector To Remain Stable

Returning credit and deposit growth, alongside the strongest fundamentals in Latin America, will ensure the stability of Chile's banking sector. Conservative lending practices have kept the quality of the sector's loans high despite the country's weak economy. Non-performing loans comprised 2.0% of the total as of February 2017, below the 2.3% averaged since 2009. The asset/equity ratio, a measure of leverage, is similarly below historical averages after a significant move within the sector to cut leverage.

Economic Troubles Not Threatening Banking Sector
Chile - Leverage Ratio & Non-Performing Loans
Source: SBIF, BMI

Capitalisation levels remain healthy, at 10.6% of GDP, up from 8.8% at the beginning of 2013. Exchange rate risks are also limited, as a strengthening Chilean peso ( see ' CLP: Negative Short-Term Outlook To Give Way To Modest Appreciation ' , March 30) and relatively small portfolio of foreign currency loans will keep the sector insulated.

Poor Sub-Optimal Adequate Good Excellent
Note: Arrows signal trend (| = improving, X = stable, | = deteriorating). Source: BMI
Asset Quality x
Funding Structure x
FX Exposure x
Capital Adequacy |
Sovereign Support Capacity x
Regulatory Body Assessment x

Structural Characteristics Of Banking Sector

Asset Quality: Non-performing loans (NPL) in Chile remain around historical lows, at 2.0% of all loans as of February 2017. Although headline growth has been relatively sluggish in recent quarters, NPLs are well below their peak of 3.2% in June 2010. NPLs will remain low in 2017 as the economy gradually strengthens, leading to higher wages for consumers and improving corporate balance sheets. We expect that the BCC's dovish bias will improve asset quality, particularly given the banking sector's historically conservative risk appetite.

Funding Structure: Chilean banks utilise much more non-deposit funding than their regional peers. As of February 2017, the sector's loans-to-deposit ratio remained near its five-year average of 1.2, well above the regional average of 0.9. However, the Chilean banking system is considerably more developed and has a greater array of financing options. Chilean banks have access to a far more liquid repo market, due to the high level of banking penetration in the country, and maintain access to foreign funding.

Banking Penetration Supports Funding
Chile - Client Loans & Loan-Deposit Ratio
Source: SBIF, BMI

FX Exposure: The Chilean banking system maintains relatively little exposure to foreign exchange rates. Although banks lend in hard currencies, loans are predominately denominated in inflation-adjusted pesos using the Unidad de Fomento (UF) conversion, which hedges against the inflationary pass-through effects of peso depreciation in light of commodity price weakness.

Capital Adequacy: Chile's level of capitalisation is low compared to regional averages, with capital as a percent of liabilities coming in at 10.6% in February 2017. However, although this headline figure is low, Chile's banks have proven adequately capitalised to deal with significant stress. None of its major banks tapped the USD5.0bn credit line provided by the BCC during the financial crisis in 2008. Chilean banks' high quality of assets reduces the need for a large buffer, although Chile is gradually adopting the more stringent Basel III international capital standards, which will reinforce the capital of the banking sector.

Sovereign Support Capacity: The Chilean government and the BCC have significant capacity to support the financial system in the event of a crisis. The government has traditionally been reluctant to run large fiscal deficits and has maintained a low level of public sector debt-to-GDP. As such, the government enjoys low borrowing costs and an ability to provide emergency funding. Moreover, the BCC has in the past demonstrated the willingness and ability to extend emergency credit lines to banks, as it did during 2008, further supporting the sovereign backstop for the industry.

Regulatory Body Assessment: Chile's main regulatory agency is the Superintendencia de Bancos e Instituciones Financieras de Chile (SBIF). Although the agency's head is appointed by the president and can be removed at will, the SBIF has managed to maintain autonomy and build a reputation as one of the most independent banking regulators in Latin America. The BCC also plays a role in the regulation of the financial system, enforcing capital requirements and acting as the lender of last resort. The BCC has a reputation as one of the most transparent central banks in the region, reinforcing Chile's reputation for institutional strength.