HONDURAS: TREASURY FINANCIAL SECTOR-LED GROWTH

UNCLAS SECTION 01 OF 04 TEGUCIGALPA 003321 SIPDIS SENSITIVE STATE PASS TO USTR: ANDREA GASH STATE FOR WHA/CEN, WHA/PPC, EB/OIA, INR/B STATE PASS AID FOR LAC/CEN GUATEMALA FOR COMMAT: DTHOMPSON STATE PASS TO EXIM, OPIC, USED IDB, USED WB, USED IMF E.O. 12958: N/A TAGS: ETRD ECON EFIN EAID HO SUBJECT: HONDURAS: TREASURY FINANCIAL SECTOR-LED GROWTH INITIATIVE REFS: A) SECSTATE 211927, B) TEGUCIGALPA 2201 ¶1. (U) Post submits the following information on Honduras' financial services sector as requested in ref A. Ref B provided an overview of the banking sector in Honduras. Washington agencies should note that the World Bank and Interamerican Development Bank are currently conducting a comprehensive review of all aspects of the financial sector in Honduras. Simultaneously, the Honduran banking association (AHIBA) has contracted a financial services consultant to provide a similar assessment to the banks. We expect results from these ongoing assessments to become available starting in early 2003. -------------- State of Development of Financial Sector -------------- ¶2. (U) Honduras is a Highly Indebted Poor Country (HIPC) with about USD 4.5 billion in outstanding foreign debt. The HIPC debt relief completion point for Honduras has been delayed by the GOH's problems in meeting IMF program targets and funding of its poverty reduction program. The result is a constriction of world capital flows to the GOH, except for concessionary loans by international financial institutions. The Honduran financial system is comprised of a troubled banking system, no capital markets to speak of, limited recourse to long-term financing, high interest rates, limited credit-worthiness of potential customers and an over-crowded insurance sector. Consumer and business financial services (credit cards, mortgages, leasing etc.) are available but expensive. Full development of the financial sector will depend on the speed and success of structural economic reforms by the GOH. The repayment record is also fairly low in some sectors of the economy. ¶3. (U) At this point, the future for financial services is cloudy. As the USG's financial services offer reflects, the most important opportunities for U.S. financial firms are probably in the insurance industry if limitations on the provision of cross- border services are lifted. Improved macroeconomic stability (if and when it comes) could spur improved prospects in investment banking, development of a securities market and increased opportunities for housing and commercial mortgages. ¶4. (U) The Honduran banking system, currently comprised of 20 private and 2 state-owned banks, is considered weak and in need of extensive consolidation. Insider abuses and heavy losses in the agriculture and real estate sectors combined to contribute to a large overhang of bad loans (estimated at 18 percent). Banks also have a large inventory of repossessed assets (ranging from mines to hotels to a medical center) with limited success in reselling. Slowed domestic and world economic activity following Hurricane Mitch and September 11, 2001 decreased demand for loans and other credit services, although some corporate business appears to be rebounding in the second half of 2002. ¶5. (U) There are few, if any, restrictions on foreign banks establishing or operating representative offices in Honduras. The limited presence of foreign banks is owed mostly to the smallness of the market. Current reserve requirements, particularly for dollar accounts, have contributed to high interest rates. With their lower interest rates, regional banks in Miami, Panama, El Salvador and even Guatemala are often the lenders of choice for the most credit-worthy Honduran customers. ¶6. (U) Banking supervision is improving steadily, with assistance from the International Monetary Fund and others, and the Maduro government in particular has shown dedication to its strengthening. Protection of property rights (particularly land tenure) and enforcement of contracts in the judicial system are weak. There are bankruptcy laws but they are rarely used. Recent legal changes allow some investment of pension funds, but the administrators of these funds are skittish about repayment prospects (in an interesting portrayal of fears on this subject, a teachers demonstration turned unexpectedly violent in the autumn of 2002 the day after the Congress adopted a law allowing teacher pension funds to buy bonds that are being issued to fund low-income housing). -------------- Comments by U.S. Financial Services Providers -------------- ¶7. (SBU) Econcouns met with Maximo Vidal, country director for Citibank in Honduras, on November 27 to exchange views. Citibank is the only U.S. bank operating in Honduras, primarily because of the small size of the market. Citibank confines itself to corporate lending and services, loan sindication and investment banking. The office hopes to help structure future GOH privatization projects. Vidal confirmed that foreign banks face few restrictions in Honduras. Vidal shared a letter that Citibank recently sent to USTR expressing support for the upcoming U.S.-Central America free trade agreement (US-CAFTA) negotiations. Citibank did not identify any particular trade obstacles in Honduras in this letter. ¶8. (SBU) Vidal, who is currently serving on the banking association board, confirmed the widely held view that there are too many banks operating in Honduras and that the GOH should focus on encouraging mergers. Commenting on the fragility of the system, he noted that about four to five banks have significant agricultural loan portfolios with high levels of bad debts. In addition, Vidal highlighted the extensive holdings of repossessed property (activos eventuales); banks are supposed to sell these within a limited period of time but have encountered problems in disposing of the assets. ¶9. (SBU) According to Vidal, regional banks (Panamanian, Salvadoran and now even Guatemalan) are making inroads because they are able to offer far lower interest rates than local banks. Individuals and companies with means are also able to travel to the U.S. and work with banks in Miami and other U.S. cities. In Honduras, in contrast, the high reserve requirements (50 percent held in Grade AA banks in the U.S. and 15 percent deposited in the Central Bank) restrict dollar-denominated loans to 35 percent of dollar holdings (30 percent to exporters and 5 percent to other borrowers). The Central Bank has expressed concerns about lowering the reserve requirements too much too quickly, because of the expansionary effect on the monetary base. The high interest rates and small market constrains the credit card industry and other financial services. Development of a reliable credit bureau would, however, be helpful to credit card issuers. ¶10. (SBU) Finally, Vidal underlined the limiting effect of the lack of capital markets. Honduras would need a medium-term issuer of three to five-year bonds in order to create a liquid secondary market. The lack of a capital market means companies and applicants for mortgages generally face short loan terms. ¶11. (U) The Honduran insurance sector is currently comprised of 12 insurance companies, 2 of which are U.S. companies, American Home Insurance and Pan American Life. The rest are Honduran- owned. It is believed that there are too many insurance companies operating in the Honduran market. The market is regulated by an August 2001 Insurance Law, which reduced the bureaucracy in obtaining the authorization to sell insurance in Honduras and which strengthened sanctions on individuals and companies purchasing insurance from non-registered firms. There is one bill currently in the National Congress which would allow cross-border insurance services, but its prospects are not rosy. The Central Bank, in consultation with the National Banking and Insurance Commission, is responsible for authorizing operating permits for national and foreign insurance institutions. Insurance companies are required to invest at least ten percent of the company's projected minimum capital in government bonds and hold between USD 1.5 to 4.8 million in capital (depending on the type of service provided) prior to beginning operations. An American Home Insurance representative commented that while foreign insurance companies seeking to operate in Honduras are subject to a slightly more exhaustive authorization process than national firms, there are no restrictions on foreign companies and that foreign and national companies compete equally in the Honduran market. -------------- USAID and Technical Assistance -------------- ¶12. (U) USAID/Honduras, which is currently developing its strategy for 2004-2010, is waiting for completion of the World Bank and the IMF Financial Sector Assessment Program (FSAP) in Honduras in January 2003. This assessment should provide a clearer idea of the current weaknesses in the Honduran financial sector and World Bank and IMF recommendations to strengthen it. The Interamerican Development Bank (IDB) has also been supporting bank supervision over the past four years through various Multilateral Investment Fund (MIF) operations. The IDB activities have improved the legal framework for supervision of the financial system and the quality of the information produced by the National Banking and Insurance Commission. Subsequently, the IDB has prepared a four-year USD 25 million Financial Sector Program proposal that is scheduled to go to their Board of Directors for approval in early January 2003. USAID/Honduras, which has worked with microfinance institutions and financial policy programs over the past decade, is currently waiting to receive the results of the FSAP and the approval of the IDB Financial Sector Program before identifying the areas where the USAID bilateral mission should work to strengthen Honduras' financial sector. -------------- Consumer Access to Financial Services -------------- ¶13. (SBU) Honduran consumer access to financial services includes car loans, credit cards, mortgages and consumer lending. Credit cards are issued directly from banks, with interest rates (for balances in lempiras) ranging from 3.9 to 4.7 percent per month. Rates for mortgages in lempiras are 16 to 20 percent per year, and 12 to 14 percent per year for those in dollars. Terms for mortgages in dollars are shorter (5 to 10 years) than those in lempiras. Banks are cautious to see if a borrower has dollar income or dollar assets before issuing a mortgage in dollars. In addition to financing through a bank, several retail stores are offering low-interest consumer credit. Other financial institutions charge extremely high interest rates and are of varying soundness. The National Banking and Insurance Commission is seeking additional oversight responsibilities for these institutions. ¶14. (SBU) Interest rates paid on savings accounts are slightly higher than those paid on checking accounts, and are higher for lempira deposits than dollar deposits. Below are the interest rates paid by Banco Mercantil as of September 2002 (interest rates will vary slightly between banks): Amount of Deposit Interest Rate (lempiras) (percent) -------------- -------------- 300-199,999 5 200,000-499,999 7 500,000+ 9 ¶15. (SBU) Hondurans' access to savings accounts may be limited by minimum deposit requirements established by banks. Several banks have considered raising their minimum deposit requirements from 100 to 1,000 lempiras (USD 6 to 60). Banks are beginning to charge between 20 and 500 lempiras (USD 1.2 and USD 30.0) monthly for accounts that fall below this minimum requirement. Hondurans with substantial means tend to hold their savings in Honduras' largest banks and Lloyds (the one foreign bank that takes deposits) or overseas because of fears of bank stability. -------------- Business Access to Financial Services -------------- ¶16. (SBU) Honduran businesses also have access to financial services that include commercial loans for start-up and expansion, trade finance, and leasing. Working capital loans (in lempiras) are usually short-term (12 to 18 months),with an average interest rate of 18 to 22 percent. Project financing loans are longer (five to seven years, depending on the project). One banker noted to Econoff that there is plenty of money to lend; the problem is finding credit-worthy borrowers who are willing to borrow at current interest rates. Honduras' economy remained fairly stagnant in 2001 and the first half of 2002, thus reducing the demand for loans. -------------- Credit Provided by Foreign Institutions -------------- ¶17. (U) Although there are few legal barriers to entry in the banking sector, the small size of the market and weak financial situation have discouraged greater foreign investment. Only two banks had majority foreign ownership in 2001 (Citibank and Lloyds) accounting for only 5.7 percent of bank capital. Panamanian Banco del Istmo is currently in the process of purchasing Honduras' largest financial group, Grupo Banco El Ahorro Hondureno (BGA). In an effort to strengthen the banking system, the Central Bank in 2002 raised the minimal capital requirement to operate a bank from 100 million lempiras (usd 6.1 million) to 150 million lempiras (usd 9.1 million). ¶18. (U) The benchmark spread between cost of funds and the lending rate is normally two to four percent, depending on the industry. This gap exists because of the reserve requirements of the Central Bank of Honduras (BCH) and currency risk. -------------- Individual Access to Investment Vehicles -------------- ¶19. (U) Long-term investment vehicles available in Honduras include savings accounts, certificates of deposit, and government bonds. There are no corporate bonds or stocks available due to the lack of capital markets. There are short-term and long-term (called bonos de caja) certificates of deposit available. Amount of Certificate Of Deposit (short-term) Interest Rate (dollars) (percent) -------------- -------------- $5,000-24,999 2.0 $25,000-49,999 2.5 $50,000-99,999 3.0 $100,000+ 3.5 Amount of Certificate Of Deposit (long-term) Interest Rate (dollars) (percent) -------------- -------------- $25,000-99,999 4.0 $100,000-199,999 4.5 $200,000+ 5.0 Pierce