Financial Outlook 2024: Challenges and Opportunities in Costa Rica's Banking Sector

Baker Tilly in Costa Rica is part of the international network recognized as one of the top firms globally by International Accounting Bulletin. The firm is strategically expanding its services in areas such as auditing, taxes, financial consulting, BPS, and legal services to provide comprehensive and personalized solutions to clients.

Luis Cardo, a journalist from the finance section, welcomes the audience to the forum titled 'Challenges of the Financial System.' The forum will discuss the financial system's challenges in 2024, review the previous year's financial performance, and explore topics like exchange rates. Esteemed guests include Aaron Chávez, financial analyst at Baker Tilly, Carlos Fernández, former manager of Banco de Costa Rica, and Luis Liberman, a prominent economist and key figure in private banking.

In 2023, the financial sector experienced a slowdown with a lack of widespread contraction but a deceleration in financial entities' accounting balances. The year saw challenges compared to the growth in 2022. Luis Liberman highlights the differences in growth between the definitive regime and free trade zones, with the former growing by 3.8% and the latter by almost 14% in 2023.

Despite not being paralyzed, economic growth is currently slower than pre-pandemic levels. In 2022, facing partially imported inflation, the Central Bank took stringent measures by increasing the interest rate to 9.9% and raising the reserve requirement from 13% to 15%. This led to significant financial constraints for banks, resulting in a loss of 87,500 million colones in financial margin.

The financial sector faced challenges due to international uncertainties, resulting in a 9% increase in interest rates in 2023. This increase caused banks to lose 87,500 million colones in financial margin, impacting their revenue from investments and loans. Additionally, banks with more assets than liabilities in dollars suffered further losses due to the revaluation of the Colón, amounting to 59,000 million colones.

In 2023, banks experienced a significant decrease in earnings, totaling 140,000 million colones. This financial setback has significant fiscal implications, although the banking industry's solvency remains stable. Despite lower profits and reduced activity, there is no crisis similar to the 2008 financial downturn, indicating a relatively stable banking system.

The speaker discusses the financial health of the banking system, mentioning that it is evaluated based on the assets, loans, and investments held by banks. Despite facing challenging years in terms of activity and profitability, recent stress tests have shown that the system is in good health.

The discussion highlights the entities within the financial system, focusing on intermediaries like banks, brokerage firms, and cooperatives. It clarifies that the analysis excludes entities like stock exchanges and savings and credit institutions that do not hold public deposits.

The speaker elaborates on the factors contributing to the stability of financial intermediaries. These include a solid financial system with impressive liquidity to address future challenges, accounting adjustments affecting private banks' assets, and the impact of exchange rate fluctuations on profitability.

The discussion delves into the effects of financial intermediation, noting how changes in interest rates, funding sources, and currency valuations influence profitability. It also mentions a shift towards higher growth in term deposits compared to current accounts, affecting tax revenues and overall financial performance.

The speaker addresses the challenges faced by financial institutions, such as margin compression due to exchange rate fluctuations, interest rate changes, funding mix variations, and the valuation of foreign exchange reserves. These factors impact profitability and tax revenues, as evidenced by the decrease in profits for the Treasury.

The discussion highlights the significant growth and profitability of cooperatives compared to state-owned banks. Cooperatives have found success in their niche market, particularly in providing credit to members, resulting in substantial earnings surpassing those of traditional banks.

Cooperatives have gained attention in the banking sector, with 22 out of 44 intermediaries being cooperatives. They have been actively advertising and offering credit in colones, contributing to the growth of the banking sector.

There is a discrepancy in credit growth figures, with the Central Bank reporting a 6% growth while nominal numbers show only a 1.7% increase. This discrepancy is attributed to the effect of currency exchange rates on dollar-denominated loans translated into colones.

The bank reports a 10% growth in dollar-denominated loans and a 3.7% growth in colones. This growth is considered positive for an economy that grew at 5%. Banks have managed to absorb losses from exchange rate fluctuations, indicating a potential stabilization in the future.

Businesses are facing challenges due to high interest rates, limiting their ability to invest and expand. Despite promises of a decrease in the monetary policy rate, the actual reduction has been slow, affecting the productive sector and exporters who face reduced income due to currency fluctuations.

Businesses rely on credit to fund investments and operations. However, high interest rates and slow adjustments in monetary policy have created difficulties for businesses, especially exporters who struggle with reduced income when converting foreign earnings to pay expenses.

The discussion highlights the impact of interest rate changes on the economy. It is mentioned that setting a floor rate in contracts can lead to financial expenses for companies if the interest rate drops. This situation affects fiscal decisions and revenue generation, as companies are experiencing lower profits and reduced income due to lower interest rates.

The conversation delves into the effects of low interest rates on the banking sector. It is noted that when there is liquidity in the market, the concept of a floor rate loses significance as clients tend to switch banks for better interest rates. This dynamic creates competition among banks, with state-owned banks having a higher percentage of current accounts in local currency compared to private banks.

The dialogue discusses the behavior of savers in response to interest rates. It is mentioned that some savers reacted to high-interest rates by converting dollars to local currency and opting for longer-term deposits. This behavior has implications for the calculation of the basic passive rate, affecting the overall interest rate environment.

The weighted average interest rate in dollars fell to 7.1% by December, despite international rates being higher. This drop was attributed to significant renegotiation of credit operations and the emergence of new credit with lower spreads, particularly through the famous tri rate. Banks are not necessarily lowering passive rates in line with the central bank's policy rate reductions.

The basic passive interest rate faces distortions due to a 15% interest tax and a 15% reserve requirement. It is unlikely that the basic passive rate will decrease significantly, even if international rates drop slightly. The central bank's policy rate cuts may not directly influence passive rates due to these distortions.

Expectations for 2024 suggest a mixed outlook. While there has been an increase in consumer confidence regarding home and car purchases, indicating potential growth in those sectors, high real interest rates may hinder business credit expansion. The overall business environment in 2024 is expected to be similar to the previous year unless significant economic growth occurs.

The speaker expresses skepticism about the economic prospects for 2024, stating that the current conditions do not indicate a positive outlook. They highlight the need for a solid banking system well provisioned for bad loans. The speaker predicts a possible consolidation of financial intermediaries in the digital sector, but does not foresee significant credit demand or a festive atmosphere in the financial system.

The speaker discusses the historical relationship between credit growth and economic expansion, noting that credit growth typically outpaces economic growth by around two times. They predict that in 2024, credit growth may not reach the traditional levels of 8% due to subdued economic conditions. The speaker emphasizes the lack of significant credit demand and suggests a potential shift towards debt consolidation at favorable interest rates.

The speaker analyzes the potential outcomes for banks and clients in 2024. They anticipate improved financial performance for banks due to stabilizing exchange rates and lucrative opportunities in fixed-rate securities. The speaker expects banks with strong liquidity positions to benefit from declining interest rates, leading to increased profitability. Additionally, they foresee a potential uptick in credit activity among institutions that did not experience growth in 2023.

The speaker discusses a strategy of debt colonization, where clients are offered credit in local currency at lower exchange rates to repay existing dollar-denominated debts. They highlight the attractiveness of this approach due to lower interest rates in local currency compared to dollar loans. The speaker predicts a movement towards debt consolidation at more favorable terms, leveraging the current exchange rate dynamics to benefit clients.

The speaker examines the operational costs of banks, noting that despite a potential increase in non-performing loans affecting profitability, overall operational costs remain stable. They suggest that the banking sector operates on a relatively low-cost platform and does not anticipate significant cost escalations. The speaker attributes a rise in the deficiency index to lower profits rather than increased operational expenses.

In discussing the financial sector, there is optimism for improved profits for financial institutions. However, concerns arise regarding the slow economic growth in Costa Rica, impacting the overall business environment. The economic growth rate is considered low, affecting sectors like tourism and leading to a lackluster year in terms of growth and development.

Clients, particularly in Baker Tilly, are showing an increased demand for credit. The reasons for seeking credit vary, from capital expenditure for business expansion to covering working capital gaps due to delayed payments. This diverse demand highlights the need for financial institutions to provide tailored banking solutions to support clients' growth and financial stability.

Despite the economic uncertainties, there are opportunities for financial entities to capitalize on. The potential improvement in net interest margins due to declining interest rates and a stable exchange rate presents a favorable environment for increased lending activities. Additionally, the high level of household debt indicates a potential market for credit expansion, especially in the personal banking sector.

Despite the official price index indicating stability, many essential products in the basic basket remain more expensive post-inflation. This situation has severely affected families, limiting their purchasing power and access to credit.

Families are currently facing challenges due to limited credit availability. While some financial entities may aggressively target customers, overall economic growth is not expected to reach previous levels unless there is a significant shift in economic conditions.

Businesses, especially sensitive to interest rates, are experiencing pressure on profit margins due to tight commercial and production margins. Additionally, fluctuations in exchange rates are affecting not only exporters but also local businesses competing with imported products.

The financial sector remains active due to high credit demand, primarily driven by ongoing investments. However, this may not translate into a significantly beneficial year for customers, as banks may need to review and restructure credit products to attract more clients.

Banks are urged to reconsider credit conditions, potentially restructuring products to offer more favorable terms to customers. This includes exploring longer loan tenures, enhancing creativity in attracting clients, and addressing informal credit practices to promote formal banking.

The speaker discusses the challenges in the banking sector, mentioning high interest rates for consumer and corporate loans. They highlight the significant costs involved in currency conversion, new credits, commissions, and bank transfers. The speaker emphasizes the need for banks to analyze their performance in 2023, address credit growth issues, and revise credit conditions for both consumer and business loans.

The speaker mentions Regulation 306, which requires higher provisions for dollar loans to non-generators. This regulation is expected to increase the cost of dollar loans instead of reducing it. The speaker expresses concerns about the potential negative impact of this regulation on borrowers who do not generate dollars.

The speaker suggests that banks, financial institutions, and cooperatives with sufficient capital should consider being more aggressive in lowering margins for new loans to increase loan volume. However, they caution that risks need to be carefully assessed before implementing such strategies.

The speaker recommends individuals and businesses to monitor key financial indicators in 2024 for making informed decisions on savings, investments, and financing. They emphasize the importance of assessing indicators like capital adequacy ratios, monetary policy rates, and economic news to guide financial choices effectively.

The speaker underscores the significance of monitoring monetary policy rates, highlighting the impact on borrowers, savers, and the overall economy. They stress the need for businesses and individuals to pay attention to changes in policy rates to make informed financial decisions amidst economic uncertainties and news-related fears.

Costa Rica faces a significant issue with the lack of financial education among its population. The speaker highlights that financial literacy is not taught from an early age, leading to a population that is not well-versed in financial terminology and economic indicators. This lack of education can hinder individuals from making informed decisions regarding topics such as inflation and economic growth projections.

In 2022, banks in Costa Rica earned 400,000 million pesos, while in 2023, their profits decreased to 228,000 million pesos, resulting in a loss of 172,000 million pesos. This financial data includes all financial institutions, such as private banks, public banks, and financial cooperatives. The profitability of banks, measured by return on equity, decreased from 7% in 2022 to 4.6% in 2023, indicating a decline in financial performance.

The reduced profitability of banks in Costa Rica has implications for investors and the overall economy. The speaker suggests that owning government bonds may have been more profitable than investing in banks due to the declining returns on equity. If this trend continues over time, it could lead to significant changes in the banking sector and affect the economy as a whole.

It is crucial for both private and public banks in Costa Rica to maintain reasonable profitability levels. The speaker emphasizes that profitability should exceed the returns from low-risk investments like government bonds. Currently, banks and financial institutions are not generating sufficient profits to support future growth, indicating a need for improved financial performance in the sector.

Due to the high costs of maintaining robust banking systems and the shift towards online banking services, there is a possibility of consolidation within the banking sector in Costa Rica. This consolidation may lead to larger banks acquiring smaller ones to achieve economies of scale. Additionally, some banks may choose to focus on more profitable areas of lending, potentially impacting certain sectors of the economy and citizens.

A robust economy requires a growing banking and financial system with increasing capital to expand activities. This stability is crucial to avoid the need for higher provisions for bad loans, ensuring a healthy financial environment.

The prolonged dominance of the dollar in financial discussions raises concerns about its effects on the financial system. Continuous conversations about the dollar's performance can lead to pressures on exchange rates and interventions by the Central Bank to stabilize the currency.

Central Bank interventions, such as adjusting reserve requirements and managing foreign exchange reserves, can impact the banking sector. For instance, changes in reserve levels can influence the availability of new dollars in the banking system.

Banks in Costa Rica repaid $900 million in foreign credits in 2023, affecting the country's reserves. Despite the significant repayment, it did not impact the Central Bank's reserves directly, indicating a shift in the banking sector's dynamics.

The banking sector faced challenges due to exchange rate fluctuations, impacting their dollar-denominated revenues. Banks that held assets in dollars experienced varying valuation effects based on exchange rate movements, influencing their financial performance.

The unpredictability of the Central Bank's actions, especially regarding exchange rate policies, creates uncertainty in the financial sector. The Central Bank's decisions can have significant implications on the banking industry, requiring adaptability to changing economic conditions.

China's success is attributed to maintaining currency stability by not allowing its exchange rate to fluctuate. Chinese reserves largely finance the US government's deficit, highlighting the importance of currency stability in economic success.

Peru and Costa Rica are two Latin American countries with dual currencies, unlike Argentina. The acceptance and circulation of foreign currencies like the US dollar vary across countries, impacting financial systems and citizen access to foreign currency accounts.

Costa Rica's financial system heavily relies on US dollars, with a significant portion of deposits, reserves, and investments denominated in dollars. The country's economy is intertwined with the US dollar, posing challenges in transitioning away from dollar-based transactions.

Transitioning away from a dollar-based economy poses significant challenges due to extensive investments, reserves, and debts denominated in dollars. The complexity lies in finding a viable solution to unwind dollar-based assets without destabilizing the economy.

Contrary to countries like Mexico, Chile, and Colombia where dollar transactions are limited, Costa Rica allows contracts and prices in US dollars. This unique practice poses challenges for the country's financial system and raises concerns for the Central Bank.

The speaker highlights the complexity of transmitting monetary policy due to a significant variable that is challenging to manage. This variable, as mentioned by Don Jorge Corrales, impacts the handling of the exchange rate. The discussion emphasizes the need to move past lamenting about the exchange rate, citing an essay by Daniel Ortiz that shows taking a mortgage loan in dollars was cheaper in most years from 2011 to the present compared to colones.

In Costa Rica, borrowers, especially individuals and families, focus on monthly payments when considering loans. Extending the loan term allows more people to afford homes, as mentioned by Carlos. The speaker stresses the complexity of the situation, urging to stop complaining as the country operates with a mix of dollars and colones. People choose the currency based on their exchange rate and interest rate expectations to suit their needs.

The discussion delves into the implications of the exchange rate reaching 306, making dollars more expensive and subsequently raising the cost of living for Costa Ricans. The speaker emphasizes the impact of taking loans in dollars, where individuals consider the devaluation risk and exchange rate against colones, highlighting the distortion in colones' interest rates.

There has been a significant increase in dollar-denominated loans in the past year, particularly in the construction sector, leading to a boom in construction projects in 2023. The speaker notes the shift towards offering properties in dollars rather than colones due to financial considerations. Additionally, there is a trend towards self-employment and passive income among younger populations, contributing to an interesting yet risky phenomenon in the market.

The availability of loans in dollars has impacted affordability, with individuals now able to purchase higher-priced items due to the exchange rate. The construction sector has experienced losses in some contracts, reflecting the challenges faced in adapting to the changing financial landscape. The discussion highlights the shift towards self-employment and passive income as a response to the evolving market dynamics.

Construction contracts in Costa Rica were traditionally done in dollars to account for increases in the cost of materials like steel and cement due to fluctuations in the exchange rate.

Builders are facing challenges with rising labor costs, as exemplified by a friend who completed a project at a loss due to delays caused by decreasing exchange rates.

There is a growing need for a derivatives market in Costa Rica to help companies manage currency fluctuations and fix costs in either colones or dollars, a dilemma exacerbated by the falling exchange rate.

Currently, there is a lack of long-term derivatives available in Costa Rica, prompting the recommendation from the Central Bank to actively seek short-term derivatives to mitigate currency risks.

Despite historical challenges, there is optimism for the development of a currency hedging market in Costa Rica, especially with pension funds requiring currency hedges after a certain level of dollar investments.

International banks with expertise in currency hedging could play a crucial role in developing the market in Costa Rica, as they have the necessary knowledge and experience to offer effective solutions to local businesses.

The discussion delves into the derivatives market, specifically focusing on synthetic derivatives offered by major financial institutions. It is noted that these derivatives are limited in availability due to the small size of the market with few participants. Some coverage is available for short-term operations such as imports and exports, but there is a lack of derivatives for long-term operations like a 25-year housing loan.

Regarding currency exchange, the speaker recommends obtaining a fixed interest rate in local currency (colones) for long-term loans instead of opting for variable rates to mitigate risks associated with fluctuations in the basic passive rate. The suggestion is to secure a favorable fixed rate for colones over dollars for extended periods to minimize interest costs.

There is a discussion on the anticipated deceleration of credit demand in dollars due to the significant interest rate differential between local currency (colones) and dollars. With colones at 12% and dollars at 7%, individuals are less inclined to borrow in dollars, perceiving lower risks of devaluation and preferring the lower interest rates on dollar-denominated loans.

The impact of regulations on currency borrowing is explored, with considerations on potential disincentives for borrowing in dollars. The speaker notes that regulatory changes may increase costs for lenders due to additional provisions, potentially prompting borrowers to shift towards colones. However, the overall impact and effectiveness of these regulations in encouraging a shift to local currency borrowing remain to be seen.

The discussion touches on interest rate expectations, highlighting the potential for international interest rates to decrease slightly in the future. Anticipated events such as upcoming elections in the United States and Federal Reserve meetings may lead to a decrease in international rates, making dollar-denominated loans more attractive. This scenario could stimulate a shift towards colones or encourage new projects in local currency.

Discussing the importance of the exchange rate in colones and the movement of spreads over the basic interest rate. Transitioning to the topic of digital financial services, highlighting the advancements in technology by financial entities offering online services with more user-friendly technology.

Exploring the potential new frontier of digital financial services and the demand from consumers for innovative services. Mentioning the role of fintech as both a threat and an opportunity for traditional banking, combining finance with technology like blockchain to enhance services.

Addressing the challenges faced by the banking sector in digitalization efforts, noting the varying levels of progress among different banks. Highlighting the need for significant advancements in digital services beyond basic transactions to provide true digital facilities to customers.

Discussing the generational differences in digital adoption, with some generations embracing digital services while others prefer traditional methods. Recognizing the importance of catering to diverse preferences and the need for substantial improvements in digitalization efforts to meet evolving consumer demands.

The discussion highlights the importance of blockchain technology in the financial sector, particularly in relation to electronic wallets, digital payment systems, and the recent surge in the value of cryptocurrencies like Bitcoin. This technological advancement allows people to potentially shift their capital to electronic currencies.

There is ongoing dialogue among regulatory bodies on how to effectively regulate entities in the financial sector without hindering innovation or leaving them unchecked. The need for a specialized regulatory framework tailored to these entities is emphasized, considering their unique characteristics and potential risks.

The evolution of banking towards digitalization is acknowledged, with a focus on reducing operational costs and enhancing customer experience. The speaker reflects on the significant progress made since the introduction of digital banking services in 2006, emphasizing the importance of segmenting customers based on their preferences for digital or traditional banking.

There are concerns raised about cybersecurity in banking, particularly regarding the risk of hacking and unauthorized access to personal and corporate accounts. The speaker expresses apprehension about potential breaches and emphasizes the importance of banks understanding their customers' needs to provide secure digital banking services.

The discussion touches on the regulation of debit and credit card usage, highlighting the increasing scrutiny faced by customers using credit cards and point of sale (POS) systems. There is a call for more comprehensive regulation to address issues such as tax implications and customer preferences for cash or digital payment methods.

Fintech companies receiving funds from individuals for investment or lending purposes are urged to be regulated as intermediaries. The speaker emphasizes the need for transparency and accountability in fintech operations to prevent misuse of deposited funds, highlighting the importance of regulatory oversight in the digital financial landscape.

Financial intermediaries play a crucial role in the digital age, facilitating transactions and providing services online. The cost of digitalization is significant, leading to a predicted consolidation of financial entities in the next decade. Smaller institutions may struggle to invest in the necessary technology to offer online services effectively.

Large banks have a competitive advantage due to access to Big Data. By analyzing consumer spending patterns through credit and debit card usage, banks can reduce lending risks. This data allows banks to anticipate economic trends and make informed decisions on credit approvals and business closures.

The digitalization of banking services has led to a redesign of bank branches. Traditional teller services are being replaced by investment and loan advisory services. The shift towards digital banking has reduced the need for multiple teller stations, leading to a more personalized and efficient customer experience.

The future of banking services involves a consolidation of financial institutions, a redesign of physical branches, and a shift towards digital transactions. While ATMs remain important, the focus is on providing personalized services and investment advice to customers. The rise of mobile banking platforms like simpe is changing the landscape of financial transactions, with a significant increase in subscribers over the past two years.

The number of people with access to mobile banking in Costa Rica has reached 1,900,000. Over the past year, transactions have increased from 372 million to 506 million, showing a significant rise of 135 million transactions. This surge in mobile transactions has seen a substantial increase over the years, with transactions reaching nearly 1 billion. The total amount transferred through mobile banking has grown from 6.5 billion to almost 8.6 billion, indicating a significant shift towards digital financial services.

In the past, traditional banking involved physical checks, requiring individuals to maintain vaults in banks to safeguard them. However, with the advent of mobile banking services like SIMPE, the landscape has transformed. Individuals no longer need to rely on physical checks, with transactions becoming more efficient and secure. The Central Bank's revolution through SIMPE has streamlined processes, making tasks like tax payments and utility bills quick and convenient, enhancing overall financial efficiency.

The evolution of banking services has led to a shift in the roles within financial institutions. There is a growing emphasis on personalized service and human interaction, especially for small business owners. Branches are now focusing on providing tailored services, such as assisting entrepreneurs in stocking up for seasonal demands. While automated transactions are cost-effective, banks are investing significantly in security measures to combat cyber threats, recognizing the need for a balance between efficiency and safety in the digital era.

Baker Tilly Costa Rica, part of the global Baker Tilly network, is recognized as one of the top business firms worldwide. The firm is strategically expanding its services in audit, tax, financial consulting, and legal areas to offer comprehensive and personalized solutions to clients. With a focus on business objectives, Baker Tilly Costa Rica aims to support clients in achieving their goals through tailored services and continuous growth in service offerings.