Latin America banking: Risk pendulum swings back to locals

New rules to boost risk-weighted assets at G-Sibs are ramping up the pressure on those banks to change their business model, and become less global. Latin American markets, until recently a battleground for global banks, could now see several of them retreat. Are local banks about to benefit from a less competitive environment?

When UBS’s global banks strategist and Latin America financials analyst, Philip Finch, listened to HSBC chief executive Stuart Gulliver’s comments after disappointing 2014 fourth quarter results on February 23 this year, he realized just how far the risk equation for global banks had shifted.

A decade previously, he had been involved with writing reports about how global banks were well-positioned to enter new emerging market banking markets and leverage their global platforms, scale economies and IT capabilities at the expense of the locals. Then, these market dynamics were seen favourably by international banking regulators, who subscribed to a view that greater geographical diversification provided less concentrated risk and strengthened banks through a business mix that spread risk exposures and earnings.

Now, here was the CEO of HSBC saying that the bank was looking at disposing of its businesses in Brazil, Mexico Turkey and the US. For Finch, the addition of these previously key markets to the list of divestments marks “a new, significant phase” in the de-globalization of what the Financial Standards Board has called Global Systemically Important Banks, or G-Sibs.

Previously, divestments from global entities such as HSBC and Citi had been peripheral – in small markets where the bank usually had low market share. Since 2011 HSBC has exited the following Latin American retail markets: Cayman, Colombia, Chile, Costa Rica, El Salvador, Honduras, Panama, Paraguay, Peru, and Uruguay. Citi has put Costa Rica, El Salvador, Guatemala, Nicaragua, Panama, Paraguay, Peru and Uruguay up for sale.

Now rumours swirl of important Latin American disposals, such as Citi selling Banamex (which the bank’s management has previously called one of its crown jewels). And the FSB’s proposed total loss-absorbing capacity (TLAC) ratio for G-Sibs is cited as a big factor in them considering putting big businesses up for sale.

Clearly Citi and HSBC’s Latin America disposal programmes pre-date TLAC and have been driven by a simple desire to improve woeful recent return-on-equity results. In October 2014 Citigroup said it would exit the consumer finance business in 11 countries ( including Peru) and HSBC has pulled out of a mixture of 43 countries and businesses in the past four years. These non-core asset disposals were driven mainly by shareholder pressure to deliver ROEs above the cost of equity.

“HSBC delivered ROEs of 7.3% in 2014 – five years after the global crisis – which is well below their cost of equity,” says Finch. “What I think we are now seeing is a movement to the next stage: these banks are moving out of what were key markets and are now under pressure from shareholders and regulators to make these very difficult decisions. That is what I found most interesting from Stuart Gulliver’s comments – he is now looking to dispose of assets that have been important markets in the past. And I don’t think [HSBC] is the only one. I think we will see more G-Sibs looking to sell previously key businesses as we move forward.”

While global banks look to rebuild returns on equity the regulators are pressing on. Alongside higher capital requirements demanded by the Basel Committee, the FSB has identified 30 G-Sibs that it believes should be subject to additional capital surcharges due to their cross-jurisdictional operations, complexity and interconnectedness.

The FSB allocates each of these banks to one of five levels of risk and applies an additional requirement for a buffer of between 1% and 3.5% (presently none of the banks attracts the top 3.5% surcharge but HSBC and JPMorgan are in ‘bucket four’ and are hit with an added 2.5% surcharge). The proposed minimum TLAC capital would be the higher of at least twice the Basel III tier-1 leverage ratio (currently 6%) and a base level of 16%-20% of RWA plus the G-Sib surcharge – taking the maximum theoretical TLAC capital to 26%. Then add to TLAC’s RWA requirement the added compliance and risk management costs and it’s easy to see why G-Sibs face an uncomfortable position.

“It’s a massive U-turn in the approach from regulators,” says Finch. “Under the G-Sib regulations, the more countries you operate in (or more specifically, the more cross-jurisdictional assets and liabilities you have) the more risk you allegedly have and therefore the greater the capital surcharge. A decade ago it was the other way around – the more markets you operated in, the greater the geographical diversification and therefore the less concentration of risk.”

The proposed regulations are expected to be ratified in November this year and become a Pillar 1 (mandatory) requirement by January 1, 2019 (to coincide with Basel III). That gives the G-Sibs a little time to wrestle with their impact and plan a global strategy that best balances global deployment of capital with profitability.

But not much time: “The market will move ahead [of the 2019 deadline] and the market will likely start to price it in almost immediately,” says Finch. “If investors start to see that some of the G-Sibs’ foreign subsidiaries are going to have to issue $X billion in bail-in-able debt and CoCos, which could cost up to 8% a year – in other words extremely expensive debt – it will be clear that this will hit margins, earnings, ROE and dividend potential. The market could price that in quickly for any bank that isn’t showing its intention about how to respond. So I think that’s why there is a lot of pressure on management to move forward and reassess which businesses are clearly underperforming.”

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