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.

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Background: The Need for Reform
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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.

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Changes in the New Law
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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.

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Profile of Honduran Banks
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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.

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A More Stable Framework
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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