Banco Central de la República Dominicana's order for banks to allocate a portion of their legal reserves to lending to specific sectors is a credit negative for the banks, Moody's said in an Aug. 3 report.

In an order published in late July, the central bank ordered that banks in the country release an aggregate of 20.4 billion Dominican pesos from their legal reserves and lend them to certain economic sectors at below-market rates. The move aims to reverse Dominican Republic's weakening economic growth, which Moody's expects will hit 5.5% for 2017.

In a sector report, Moody's warned that the central bank measure is a credit negative for Dominican banks given the ensuing increased lending exposure to riskier segments. The move, the rating agency noted, will require banks "to increase exposure to riskier lending to consumers, agribusiness, manufacturing, lower-end housing and small and midsize enterprises (SMEs) at below-market rates, thereby reducing profitability and raising asset risks."

Moody's expects the mandated lending effort will reduce banks' return on assets by about 10 basis points, although strong net interest margins will hold return on assets at about 1.5%, slightly above the 1.1% average for Latin America.

"The key risk to profitability is an increase in loan-loss provisions as banks increase their exposure to less creditworthy customers and are unable to fully price for the risk," Moody's cautioned. The riskier groups include individuals, agribusiness, commerce and SMEs, the rating agency noted.

Meanwhile, Moody's said asset risks among banks are inherently high because of continued rapid loan growth, with expansion in private-sector credit averaging 15% between 2014 and 2016. Due to a lack of financial depth, credit growth will continue to grow and the banks do not have strong capital buffers to cushion the ensuing deterioration in asset quality, the rating agency added.

As of Aug. 3, US$1 was equivalent to 47.27 Dominican pesos.