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Argentine banks better prepared than in 2001, but profit concerns remain

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Argentine banks better prepared than in 2001, but profit concerns remain

Tighter regulations implemented since Argentina's 2001 economic meltdown, along with a defensive strategy of driving profits with securities rather than lending, will likely shield banks from severe damage this time around.

Still, questions remain as to how a mostly liquid and well-capitalized banking system will be able to continue with its current model of investing in Banco Central de la República Argentina's Leliq instruments as a new government takes over. A strong interdependence between a financially struggling sovereign and the financial industry could put the latter at risk.

"Leliq notes are today banks' largest liquidity shelter as well as their highest source of profitability. The incredible results seen in the second quarter are basically (from) Leliqs. Any reversal related to that will generate a disruption in profits," Valeria Azconegui, a senior analyst at Moody's, said in an interview.

Unofficial estimates put banks' holdings in central bank debt at roughly 20% of total assets, with even higher percentages in private banks' portfolios. And while banks have used high-yield peso denominated instruments as mere repo loans, some are becoming more skeptical about the sustainability of these investment mechanisms.

Rollover rates in recent Leliq auctions have fallen precipitously, a signal that banks already are looking elsewhere for investment options. But there are limited alternatives.

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Given double-digit falls in credit since the economic recession began, inflation and uncertainty have pushed banks away from lending and into government securities. They also have built up their capital buffers from incoming deposits.

But Argentina's Aug. 11 presidential primaries, which made Peronist opposition candidate Alberto Fernández the front-runner to win, has threatened those operations. In the two weeks after the primary contest, Argentine depositors withdrew an estimated $5.86 billion from U.S. dollar accounts, roughly 18% of total deposits in the system.

So far, financial institutions have been able to withstand the pressure and are nowhere near the level of crisis seen in 2001 and 2002, when a bank run prompted the government to freeze accounts. A recent decision by President Mauricio Macri to enact currency controls reportedly has tempered the pace of withdrawals, and banks are far better capitalized today than they were then. According to central bank data, Argentina's financial system's capital buffers were 85% above regulatory requirements as of mid-2019, while liquidity levels grew 15.1% year over year to represent 60.5% of total deposits.

"While liquidity buffers are still super wide as a result of the 18-month recession, it is a sign that the vulnerability is greater than before," Azconegui said.

Liquidity buffers

According to S&P Global Ratings, Argentine banks will operate under a "very challenging" economy in the upcoming quarters, with deterioration in asset quality, credit losses and largely no real-term credit growth. The underlying macro environment has dragged credit ratings for institutions down.

However, the channeling of funds by lenders into high-yield peso denominated instruments from the central bank has allowed them to remain profitable. The revenues streaming in from central bank securities provide enough resources to offset higher charges for provisions in response to a jump in delinquency, the rating agency said.

Over the past 18 months, Argentina has been hit repeatedly by severe currency shocks and has suffered continued rampant inflation. But as lenders have increasingly turned to the high-yielding Leliq notes, which currently yield around 85%, their profits have actually improved.

Aggregate second-quarter 2019 net income for Grupo Financiero Galicia SA, Banco Santander Río SA, BBVA Banco Francés SA and Banco Macro SA totaled 30.88 billion Argentine pesos, up 199.8% year over year according to data compiled by S&P Global Market Intelligence. Most of the improvement came from Leliq revenues; at Galicia, for instance, net income from financial instruments skyrocketed 924%.

Banks have pumped a large share of deposits into the securities, which the central bank uses to prop up the peso with attractive rates for fixed terms, that can generate more profits than foreign currency and exceed the inflation rate. Faced with a stagnant loan demand and GDP contraction, banks have turned massively to the instruments. The stock of Leliqs amounted to 1.039 trillion pesos, as of Aug. 30, according to central bank data. In comparison, Argentina's monetary base stands at 1.314 trillion pesos.

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The rollover risk

However, this mechanism has risks, particularly if depositors begin to withdraw funds in the lead-up to the October presidential elections.

Banks renew their Leliq holdings daily, profiting from the wide margin between the interest paid on deposits and those earned from the notes. However, when deposits evaporate, banks are not able to roll all of the funds into new Leliqs. That then forces the central bank to step in to fill the gap. The central bank had to do just that Aug. 30, when it injected about 8% of base money after the day's auction fell short.

"There is a very big risk that liquidity that is no longer in the banking system, will create pressures for the peso and we will see a further deprecation of the exchange rate," Oxford Economics analyst Pamela Ramos said in a telephone interview.

Moreover, this risks BCRA's commitment with the IMF of zero growth in the monetary base, aimed at lowering inflation, which is still hovering around 50% a year, and has started growing again. The latest central bank survey sees inflation at 55% in 2019.

Ongoing uncertainty

During the presidential campaign, opposition front-runner Fernández called for modifying or dismantling the Leliq scheme and lowering interest rates. According to Ramos, a strategy of lowering rates looks "unfeasible" at the moment. "If you lower these interest rates, depositors are not going to have the incentive to remain with deposits in pesos, which begs the question what happens to the current monetary scheme."

The man who oversaw the creation of that scheme, Central Bank President Guido Sandleris, said that while Argentina had struggled to find a proper path in macroeconomic terms, the "remarkable" functionality of the financial system was an exception, which boasted of much higher liquidity than most international banks. "Despite the volatility of recent weeks, the financial system is solid," he said in a press conference. "This is an example of a basic consensus that we have been able to build and that protects savers."

As of Sept. 4, US$1 was equivalent to 55.86 Argentine pesos.