HONDURAS ECONOMIC REFORM: BANKING COMMISSION REFORM

UNCLAS SECTION 01 OF 02 TEGUCIGALPA 000008 SIPDIS SENSITIVE STATE FOR WHA/CEN, WHA/EPSC, AND EB STATE PASS AID FOR LAC/CAM STATE PASS USTR TREASURY FOR DDOUGLASS E.O. 12958: N/A TAGS: EFIN ECON PGOV HO IMF SUBJECT: HONDURAS ECONOMIC REFORM: BANKING COMMISSION REFORM LAW IMPROVES BANK CRISIS MANAGEMENT REF: A) 04 Tegucigalpa 2765 B) 04 Tegucigalpa 2826 C) 03 Tegucigalpa 2062 D) 04 Tegucigalpa 232 ¶1. (U) SUMMARY: In September 2004, at IMF insistence, the GOH passed four banking reform laws aimed at strengthening the nation's financial system. This is the third in a series of four cables that analyze each of these laws, assess their impacts on the Honduran financial system, and outline challenges of implementation or additional needed reforms that remain. Refs A and B analyzed the reform of the deposit insurance agency and the Central Bank; this cable focuses on the reform of the National Banking and Insurance Commission. ¶2. (U) The new Banking Commission law makes one major change to Honduras' structure for financial supervision: it transfers responsibility for resolving and recapitalizing failed banks from the deposit insurance agency, FOSEDE, to the Banking Commission. While FOSEDE oversaw the closure of one bank and the sale of another in 2002, the cost of these actions was high, and there is a strong consensus that the Banking Commission is the appropriate entity to handle such cases in the future. The new legal framework should, it is hoped, allow some needed consolidation of the banking sector to take place, while reducing the costs of unnecessary interventions, and keeping low the risk that a bank closure or liquidation would spread a panic through the system. The law also makes some minor changes to the structure of the Commission's board. End summary. -------------- Background: The Need for Reform -------------- ¶3. (U) As summarized in ref C, a 2003 joint IMF/World Bank "Financial System Stability Assessment" for Honduras concluded that the Honduran banking system is "highly fragile at a systemic level, impairing sustainable economic growth," and outlined several reforms needed to strengthen the system. These reforms were then incorporated into the Letter of Intent signed by the GOH and the IMF in February 2004 (ref D),which required the passage of four financial sector reform bills: the Deposit Insurance Law; the Central Bank of Honduras Law; the Banking Commission Law; and a new Financial Institutions Law. ¶4. (U) Specific to the Banking Commission, the report found that the existing legal and institutional framework for managing banking crises was inappropriately designed, too costly, and inefficient. The improvement of this framework was one of the four key recommendations of the report. Until the recent reforms, resolving and recapitalizing distressed banks was the responsibility of the national deposit insurance agency, FOSEDE. During the last bank failure in Honduras in May 2002, FOSEDE took over and capitalized two small banks, Banco Capital and Banco Sogerin, using resources borrowed from the Central Bank. The hope was that the injection of capital and some time under FOSEDE's administration would reverse the banks' deterioration. While Sogerin was made solvent and subsequently sold, Banco Capital was closed and liquidated before the end of 2002, casting doubt on the usefulness of recapitalizing the bank in the first place. -------------- Changes in the New Law -------------- ¶5. (U) The Banking Commission reform law and the FOSEDE reform law transfer the responsibility for the restitution of troubled banks from FOSEDE to the Banking Commission, as recommended by the World Bank/IMF assessment report. As discussed in ref A, this move will both simplify FOSEDE's mission and remove a major financial burden, as the intervention by FOSEDE on behalf of Banco Capital and Banco Sogerin in 2002 drove FOSEDE deeply into debt with the Central Bank. Furthermore, the reform is seen as a prudential measure: it is the GOH hope that transferring responsibility for the restitution of troubled banks to the Banking Commission will counter the temptation to keep a weak bank alive with costly injections of capital in cases where the best course is to accept the inevitable and move directly to the closure and liquidation of a weak bank. ¶6. (U) The law also makes various changes to the organization of the commission - modest but positive steps in the establishment of a modern, independent banking commission. Previously, the Banking Commission had been made up of three members and two alternates; the new law removes the alternates, since, according to a Banking Commission official, they were drawing a salary while doing nothing. The new law also tightens the requirements for who may serve on the commission, excluding directors or owners of banks or other financial institutions, any holders of non- performing loans, or anyone who has been sanctioned or found guilty of any financial crimes. -------------- Profile of Honduran Banks -------------- ¶7. (U) Over the past several years, as public awareness of the weaknesses in the banking system has grown, Hondurans have increasingly concentrated their deposits in the largest banks. Deposits in the top five banks operating in Honduras (Banco Atlantida, BGA, Banco de Occidente, Ficohsa, and Bamer) accounted for 55 percent of deposits in 1999, 66 percent in 2002, and 69 percent as of September 2004 (see table below). Total Total Total Bank Assets Loans Deposits -------------- -------------- -------------- -------------- Banco Atlantida 15,592.5 9,085.1 9,807.8 BGA 15,281.3 7,945.2 8,282.3 Banco de Occidente 12,547.8 5,762.1 9,403.2 Ficohsa 12,182.3 7,110.1 7,583.3 Banco Mercantil (Bamer) 10,223.9 6,216.0 6,606.8 Banco del Pais 9,899.9 5,564.6 6,303.2 BAC Honduras 6,170.5 2,406.3 1,928.3 Banco Uno 2,770.3 1,502.6 1,636.6 Banco Continental 2,458.1 1,260.9 1,210.8 Banhcafe 2,367.4 790.4 1,360.8 Banco Promerica 2,087.0 876.7 1,039.0 Ficensa 2,042.4 1,464.5 1,099.8 Banco de los Trabajadores 2,022.1 1,451.4 978.5 Banco de Honduras (Citibank) 1,639.5 591.3 1,001.0 Lloyds (Cuscatlan) 1,576.8 521.3 1,107.1 Banco Futuro 1,363.4 688.2 679.8 TOTAL 100,225.2 53,236.7 60,028.3 All figures in millions of Lempiras, data as of September ¶2004. (At that time, USD 1 = 18.43 Lempiras) Source: National Banking and Insurance Commission. -------------- A More Stable Framework -------------- ¶8. (SBU) Comment: There is a widespread consensus among both private bankers and government officials that the Honduran banking sector, with sixteen different national and regional banks operating in a country of just seven million people, is overcrowded and ripe for further consolidation. However, the elimination of two very minor banks in 2002 was handled in a manner that was both inefficient and costly. Under the new legal framework established by the September laws, the hope is that some consolidation can be allowed to take place, at a lower cost to the government than was the case in 2002, and while minimizing the risk that a bank closure or liquidation would spread a panic through the system. End Comment. Palmer