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.

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State of Development of Financial Sector
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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).

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Comments by U.S. Financial Services Providers
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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.

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USAID and Technical Assistance
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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.

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Consumer Access to Financial Services
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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.

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Business Access to Financial Services
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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.

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Credit Provided by Foreign Institutions
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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.

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Individual Access to Investment Vehicles
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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