Foreign Commercial Banks in Chile: An Assessment

1. Foreign Commercial Banks in Chile: An Assessment John C. Edmunds Professor of Finance April 2007

2. Outline • Brief History of the Chilean Commercial Banking Sector • Spanish Banks’ Entry Strategy • Rise of Non Bank Financial Intermediaries in Chile

3. Outline, 2 • Performance of Foreign Commercial Banks in Chile • Praise and Criticisms of Foreign Commercial Banks in Chile

4. Brief History • Chile’s financial services sector was very similar to the financial services sectors of other Latin American countries until 1981-1982. • The system consisted of classic commercial banks, controlled by rich families. • Loan portfolios were too heavily concentrated in “préstamos vinculados”.

5. Brief History, 2 • In 1981 Chile’s famous pension system came into existence. It was too small to make any difference until 1984. • In 1982 Chile suffered a major banking collapse. This was similar to the collapses suffered in Venezuela, Ecuador, Mexico, Argentina, and other countries.

6. Brief History, 3 • Loan defaults in the 1982 crisis caused a domino-like series of bank failures. • Chile’s response was to make fundamental changes to the design of its national financial system. • These changes worked. The economy grew at 6% or more per year from 1984-1997.

7. Brief History, 4 • Chile’s policy toward the commercial banks was to regulate them stringently, and to allow them to make high profit margins so that they could rebuild their capital and repay the bailout loans that they received from the Central Bank. • This worked as planned. The banks became healthy. Tthere were no more bank failures.

8. Spanish Banks’ Entry Strategy • There were foreign banks operating in Chile before BCH, Santander and BBV made big increases in their presence, but the entry of the big Spanish banks caused a major transformation in the Chilean banking oligopoly. • Foreign controlled banks made 14% of bank loans in 1995 and 44.7% in 2000.

9. Spanish Banks’ Entry Strategy, 2 • The big Spanish banks bought controlling blocks of shares in locally controlled banks. There was no pressure from the Chilean government. • BCH bought control of Banco de Santiago in 1991, Santander bought 86% control of its local affiliate in 1996, and BBV bought control of BHIF in 1998.

10. Rise of Non Bank Financial Intermediaries in Chile • During that time period when Spanish were entering, the commercial banks gradually lost market share in the Chilean financial services sector. • The pension funds became the big suppliers of capital. They financed big Chilean companies that developed major infrastructure projects.

11. Rise of Non Bank Financial Intermediaries in Chile, 2 • After 2002, the Chilean pension funds bought large amounts of common stock. After that the stock market became a potential source of capital for Chilean companies. • Mutual fund management companies and insurance companies also grew rapidly.

12. Foreign Ownership of Non Bank Financial Intermediaries in Chile • Four of the top five pension fund administration companies are controlled by foreigners. • At lest one of the insurance companies is controlled by foreigners. • Local department store chains have recently set up banks and those are locally controlled.

13. Performance of Foreign Controlled Banks in Chile • Commercial banks in Chile are very profitable. Their capital adequacy ratios are also very strong. • This underpins the Chilean financial system and prevents collapses but is evidence of oligopoly and lack of competition.

14. Performance of Foreign Controlled Banks in Chile, 2 • Foreign controlled banks are perceived as hard-nosed and inclined to lend only to big companies and wealthy individuals. • Locally controlled banks are perceived more or less the same way. This is because locally controlled banks are not allowed to loan money to businesses that are controlled by the same local wealthy family.

15. Performance, 3 • Foreign controlled commercial banks are perceived as having made lending practices more objective and professional. • In that sense their expansion in Chile helped the Chilean bank regulators accomplish their objective, which was to prevent a repeat of the 1982 collapse of the commercial banking sector.

16. Praise and Criticism of Foreign Banks Operating in Chile • Foreign banks are seen as having made the Chilean commercial banking sector more stable and less vulnerable to another collapse like the one in 1982. • Foreign banks are seen as having speeded the modernization of the Chilean commercial banking sector.

17. Praise and Criticism, 2 • Commercial banks in Chile are criticized for (1) lending too much to consumers; • and (2) not lending enough to medium-sized businesses that could grow rapidly and create new high-paying jobs if they could get more access to capital.