The continuing depreciation of the colon, Costa Rica's currency, is credit negative for the country's banks, as it will aggravate asset risks on U.S. dollar-denominated loans, according to Moody's.

Rising U.S. interest rates have driven the slump in the colon, increasing both public and private banks' exposure to risks given that Costa Rica has one of the highest proportions of dollar-denominated lending in Latin America, Moody's said in a sector report. Furthermore, Costa Rica has a significant foreign exchange mismatch on bank borrowers' balance sheets: about 50% of loans are dollar-denominated, with local-currency earners holding about 70% of these loans.

Compared to Costa Rica's public banks, private lenders have a much higher level of dollar concentration, reflecting their limited access to colon funding, Moody's said. Meanwhile, the country's two largest state-owned banks, Banco Nacional de Costa Rica and Banco de Costa Rica, attract more colon-denominated funding because the state guarantees all their deposits and senior obligations. Borrowers of public banks also have fewer currency mismatches compared to those of private banks, Moody's noted.

Monetary policy tightening in response to the continued rise in U.S. interest rates could further increase asset risks, as it will constrain the repayment capacity of borrowers of colon-denominated loans, Moody's said. In addition, rising credit costs could at least partially counter any benefit gained by Costa Rican banks from rising local rates, which will contribute to asset risk, the rating agency noted.