Peruvian interest rate caps could undermine financial inclusion efforts

Peru's recently approved law obliging Banco Central de Reserva del Perú, or BCRP, to set interest rate caps for bank loans every six months could prove a major setback to the country's financial inclusion efforts, experts say.

The new legislation, which mainly aims to lower consumer and SME loan rates, arrived on the back of Congress' approval of a second round of pension withdrawals, and will pile on to the Andean nation's rising regulatory risk levels, according to Donita Rodríguez, head of macroeconomic analysis at Apoyo Consultoría, a Lima-based consultancy.

Should banks and other financial intermediaries be prevented from applying interest rates that adequately reflect the risk of granting loans to riskier credit segments, they simply will not lend to them, focusing instead on richer individuals and larger companies, Rodriguez said. That could drive low-income sectors to informal credit markets, where annual rates can climb as high as 800%, the economist added.

"Citizens and entrepreneurs will have fewer chances of accessing loans, informal markets would be promoted, and we would take a step back in financial inclusion," Economy Minister Waldo Mendoza said on Twitter the day the law was passed. The law was also criticized by bank regulator SBS, banking association ASBANC, and the central bank itself.

While President Francisco Sagasti has until Feb. 3 to veto the law, there is likely enough popular support for the legislation in congress to override such a move.

Populist threat

How such a policy will be implemented by the central bank will largely depend on who replaces longtime BCRP governor Julio Velarde, who is stepping down before August. While few believe that Velarde would condone any caps that would adversely impact loan disbursements, his successor may take a more aggressive stance.

Several populist-leaning candidacies are in contention for the country's April presidential and legislative elections, and those in charge of appointing Velarde's replacement may ultimately favor a more interventionist central bank.

"Our assumption remains that we will have another government that will continue to uphold macroeconomic stability and seek to halt these types of measures, but its capacity to do so will depend on the composition of the next Congress," Apoyo's Rodriguez said.

For Cesar Martinelli, a Peruvian professor of economics at George Mason University, "this is an issue of a slippery slope, and history matters." When Peru last experimented with greater government control over banks in the 1980s, including rate caps, the country soon spiraled into hyperinflation, he added.

Between 1979 and 1990 when rates were curbed in Peru, credit as a percentage of GDP fell to 4% from 14%. By contrast, since reforms did away with caps in the 1990s, the figure has risen to almost 45% of GDP.

"If you're in Colombia, where there's never been hyperinflation, you can talk about these types of measures more freely. But in Peru, you're touching a very sensitive nerve," Martinelli said.

Being at central bank board meetings or influencing its decisions will now be a very important objective for politicians, who will be tempted to use rates to gain electoral favor among segments of the population affected by high credit card and consumer loan rates, the economist added.

The biggest losers

Yet implementing aggressive rate caps most threatens individuals and small companies that were recently incorporated into the formal banking system, experts said.

"The fear is that the caps could end up restricting the access to credit of the riskiest [credit] segments, which would have an adverse effect on the process of financial inclusion we've seen in recent years, and a rebound in informal lending," Apoyo's Rodriguez said.

Smaller financial institutions focused on microfinancing also could suffer, as they lack the ability to easily reduce their exposure to those riskier lending segments.

"We are definitely concerned about the impact the law may have on financial inclusion and on smaller companies in the Peruvian financial system, such as municipal and micro-credit institutions," Stefany Campos, head of budget modeling and planning at Banco BBVA Perú SA, said in an email.

Banks are protesting the law "out of principle, because they are concerned about any state intervention in their margins, but at the end of the day they have the capacity to protect themselves," Martinelli said.

"While the biggest loser here is financial inclusion, banks know the autonomy of the central bank has been critical to the stability and growth of the country, with very low inflation, and they see that under threat," he added.