Financial and Banking System of Chile - Research Paper Example

Financial and Banking System of Chile Geography The country Chile is a country located in the Latin America. It is situated south of Peru and west of Bolivia and Argentina as shown in the figure 1. The country fills a narrow strip of 2,880 miles (4506 km). The country is located in between the Andes and Pacific. The country’s 1/3 rd area is covered by the towering ranges of Andes. To the north of the country is the driest place of the earth that is Atacama Desert. In the centre of the country is a 700 mile (1127 km) long that is a thickly populated valley. The valley contains Chile’s most arable land. Towards the south of the country and at the southern tip of the country’s mainland is located the Punta Arenas. Punta Arenas is the southernmost city of the world. Beyond the mainland the Magellan Strait and Tiera Del Fuego is located an island that is divided in between the countries of Chile and Argentina. The southernmost tip of South America is the Cape Horn which is a 1,390 foot (424m) rock that is located on the Horn Island. The southernmost point is under the Jurisdiction of Chile. Total area of Chile is 292,260 square miles that is 756,950 sq km. The total land area of Chile is 289,112 sq mi (748,800 sq km). Figure 1Map of Chile III. History of the Country Chile in the beginning was under the control and regime of Incas that is located in the north and Araucanos in the south. Chile has attained its independence from Spain on the year 1818. Diego Portales have fought with Peru during the time of war in order to expand and widen its Chilean territory. Chile has also fought war with Peru and Bolivia. In the year 1970 Salvador Allende has become the first president and he was elected n during a Marxist program. Allende was killed in the year 1973 by a military coup. Pinochet was elected as the president after Allende. During the end of the 19th century the government consolidated its position. Chile has expanded and widened its territory towards the north .During the 20th century the parties have won number of seats. The increasing numbers of leftish belonging to the Democratic Party were involved in the leadership of the labor unions. Chile is now moving towards a new direction by conducting Chilean presidential election during the period of 2009-2010. IV. The Country’s Financial System a. Historical Overview The economy of Chile is affected and influenced by slowdown in the economy across the world. The government was conscious due to the economic slowdown and the decrease in the GDP of the country therefore in order to stabilize the economy the Central bank of Chile have decided to adopt various monetary measures for reducing the rate of interest to around 0.5%. The current account surpluses which was experienced by Chile in the previous years have disappeared and during the period of 2009. The yield that is derived from the Central bank has fallen significantly and therefore the spread of the Chile sovereign have increased remarkably. The central bank of Chile is an institution that determines or identifies the exchange and the monetary rate policies. When the rate of GDP has fallen more than 6% due to the failure of the banks and in order to minimize the problems or the constraint of the financial structure of the country, the financial services of Chile is supervised and regulated by different forms of institutions in respect to the type of financial services. The direct influence of the global financial crisis on Chile in case of the conservative regulation has lead to the banking crisis in the year 1980.the banking crisis has lead to the generation of low international financial level and lower level of integration and the financial market. The economic slowdown has affected the financial and banking structure of Chile and particularly in the areas of credit cards and also retail lending b. Present Monetary Laws and Regulations Chile is mainly characterized by a concentrated banking system with number of small institutions. The present monetary rules and regulations of Chile on the basis of the recommendation of the Basel III regulation reflect the capital ratio of the banking system of the countries. The most important and the significant monetary laws and regulation of Chile is in relation with the foreign currency. The central bank monetary policy of Chile is based on the floating exchange rate system and the main or the prime goal of the monetary policy is price stability. The monetary policy has been introduced in such a way that it is a counter cycle for reducing or decreasing the volatility that exist in the output and inflation. The existence of the inflation target is related to the short and the medium term target. The Central Bank of Chile has fixed the target for the inflation rate to 3% annually. Therefore the monetary policy of Chile is based on the variation that exists in the consumer pricing index. The monetary policy in Chile is carried out by the Central Bank by investigating the interbank interest rate on a daily basis. The implementation of the monetary policy and regulations influences on the functioning of the sound financial system. Monetary policy influences the future inflation of Chile. The main reason for the modification or the changes that are adopted in the monetary policy and regulations of Chile are at the time when the rate of inflation is not in accordance with the target and the extent of the stimulus that is expected from the monetary policy. The main objective of the monetary policy is to expand in consideration with the asset prices and the growth of the aggregates and also considering the credit position of the country (Goldstein and Martin 603-632). c. Types of Financial Institutions operating in the country Chile’s financial system has undergone major changes and development over the past 30 years. The no. of participants in the financial system has increased and so do the variety of products and depth of the market. The financial system of Chile is well developed as compared to the standard of emerging markets and the standards of many of the member countries of OECD. This particularly applies with respect to the long maturity that is available in the fixed income market. The market has benefitted from the development of the compulsory private pension scheme. The financial sector of Chile is compartmentalized. What this means is that the banks in the market does not take part in the equities business or own business in the insurance industry. All the companies are separate entities and run separate businesses but many of them are functional under a conglomerate or group of companies. The financial system of Chile is quite matured and did perform quite well during the period of financial crisis especially when compared to other OECD countries. There were not major market failures that were observed and it was found that the financial institutions recovered pretty quickly after the crisis was over. This is due to the fact that the financial system of Chile is pretty conservative in structure and they exercise good caution before they introduce any new and complex financial instrument. The current move in the banking sector has been to consolidate the credit information that concerns different banks and non-banks in order to enable informed credit ratings of different retail customers and also limit the negative impact on the bank soundness. It is found that in Chile the different financial services are regulated by different institutions and the type of regulatory institution depends on the type of financial services that is considered. The banking sector in particular is regulated by the Superintendence of Banks and financial institution in short SBIF and the Chilean central bank (OECD 139). The securities and insurance sector is regulated by the Superintendence of Securities and insurance. The pension system and the unemployment insurance are on the other hand regulated by the superintendence of pension system. The insurance sector in Chile was also one of the sectors that was least affected by the financial crisis. Most of the players who operate in the insurance sector in the country are subsidiaries of foreign companies many of whom were affected by the market turmoil. Some of the characteristic of the insurance market of Chile is that it is highly efficient and is characterized by active product development. The majority of share of insurance market is held by the foreign controlled insurers. The market is effective and provides an opportunity in which new products that relates to pension schemes can be launched. d. The Central Bank The Central bank of Chile was started during the year 1925. The main aim and the objective of the Central Bank of Chile were restructuring the monetary and the financial policy of the country. The legal laws and regulations have assigned responsibility to the Central Bank for implementation of the monetary policy and various instruments of the foreign exchange policy. Under the floating exchange rate system the central bank of the country is provided with the option and the facility for intervening in the market through the foreign exchange rate and its operations. The central bank regulates the activities and the operations of the various sectors and facilitates the financial institutions to carry out their business in other countries and also investment that is made in abroad. The Central Bank of Chile is considered as an autonomous bank that is responsible for determining the foreign exchange rate and monetary policy of the country. The activities or the performance of the Central bank of Chile are limited or restricted since the countercyclical moves are interfered by emphasizing and stressing on the international reserves. The Central Bank of Chile carries out its operation by controlling the liquidity base and supply. The supply of liquidity is mainly ascertained and determined by maturing the bonds and the promissory notes and also by its new debts thereby controlling the liquidity of the bank (Morande and Tapia). e. Bank Regulation It is found that during the financial crisis that gripped the world the financial institutions of Chile performed more strongly that the many other OECD countries. However there is always a scope for improvement in terms of regulation. During the global financial crisis no major banking failures occurred in Chile. After suffering some initial shocks during the global financial crisis the Chilean baking system recovered quickly from the affects of global financial crisis. This is due the fact that the strong regulatory framework in Chile means that the market is cautions to the authorization of new and complex financial instruments. The Chilean financial system proved that it was resilient during the financial crisis however it does not mean that there is no scope for improvements. Although the fact remains that the Chilean banking system proved to be resilient during the financial crisis, there are several steps that the government could take to modernize and supervisory framework so as prevent vulnerabilities from occurring in future. There are several steps that the government could take to modernize the regulatory and supervisory frameworks of the banking system in the country. There has been current move by the government to consolidate the credit information of banks and non-banks for the retail customers in Chile so that the possible negative impact on the bank soundness may be limited. The main reforms that took place in Chile in the recent years started after the middle of 1970’s. It was during this year that that the country left the Andean pact. The country started to pursue a different economic model from that of Peru and Colombia (Orozco 5-6). The main reforms that occurred in the banking sector was focused Privatization of many of the corporations as also it involved loosening of the restrictions on mandatory credits and on liberalization of prices. The interest rates were allowed to fluctuate and in many cases the effective interest rate was decided by the parties’ that were engaged in the transactions. Later on the Chilean financial system was severely hit by the increased inflation of the American financial market and Mexican crisis. As because an increase in financial liberalization was not met with an increase in the regulation, so the external factors severely impacted the financial system of Chile and had a serious negative impact on the Chilean financial system. After the financial crisis that occurred new regulations were introduced in the market in 1986 that were aimed at strengthening the requirements of capital, tried to limit the bank’s tendency to take risks. These regulations also forced the banks to disclose more information and promoted bank transparency. f. Commercial Banks operating in the country 1. Commercial The lists of top 5 banks in Chile as per the assets under control as per figure 6 in are Banco de Chile which controls about 21.2% of the total assets in the market, Next to follow in Santander which has about 15.1% of the total assets in the market under its control. Next in line is the BCI which has 14% of the total assets in the market under its control. The bank that follows next is the Larrain Vial with 5.9% assets of the market under its control and this is followed by BICE with about 5.4% of the assets under its control. As per the market share of the net fees and commissions received by the banks the bank that comes first is Banco de Chile with about 19.8% market share. This is followed by Santander which has 16.4% market share. The bank to follow next is BCI with 14.7% market share. This is followed by CorpBanca with 11.4% market share and Itau with 5.2% market share. As per the market share on the basis of amount of total loans given the bank that comes first is Santander with 19.2% market share, followed by Banco de Chile with 18.4% market share. This is followed by BCI with 12.9% market share and comes in 3 rd position. The Corp Banca with 7.6% market share comes at the 4th position with 7.6% market share and Itau comes 5th with 5.1% market share. As per the % of market share that is occupied by different banks depending on the amount they give as commercial loans the Banco de Chile comes first with 18.3% market share followed by Santander with 17.3% market share. BCI follows third with 14.2% market share, Corp Banca follows fourth with 9.3% market share and Itau follows 5th with 5.7% market share. Figure 4 and figure 5 shows the market share of demand deposits of banks in Latin America and ROAE, OPERATING MARGIN, LOAN LOSS PROVISION RATIO AMD EFFICIENCY RATIO of banks in Latin America respectively. Figure 2 Market share of demand deposits of major banks in Latin America (Banco de Chile 15) Figure 3 ROAE, OPERATING MARGIN, LOAN LOSS PROVISION RATIO AMD EFFICIENCY RATIO of banks in Latin America (Banco de Chile 19) Figure 4 Total loans, Commercial loans, Net fees and Commission, Assets under management of banks in Latin America (Banco de Chile, 14) 2. Savings & Mortgage Banks The saving and the mortgage banks have been established in Chile for minimizing the time lag or the difference in the assets and liabilities. The saving and the mortgage banks are mainly considered as the intermediaries that facilitates during the time of crisis. The government has induced the habit of saving among the people after the crisis in order to develop their level of confidence and safeguarding their savings. The development of the capital market has lead to the introduction and the development of saving and mortgage banks in Chile. The mortgage banks mainly yields the major portion of the Chilean treasuries. The bank of Santiago of Chile is engaged in providing of the mortgage. The mortgage bonds in Chile are issued by the banks. The large group of investors has enforced the habit of savings and lead to the generation of savings and the mortgage banks (Subercaseaux 105-128). 3. Development Banks Most of the research and literature in the field of state owned banks either exclusively focuses on commercial banks or mixes commercial banks with development banks. Although the important point to be noted here is that these two are very different types of institutions. There is no universal definition of development banks. Often these banks are described as financial institutions that are concerned with providing long term capital finance to projects that have positive externalities. In Latin America there exists a large no. of financial institutions that define themselves as development banks. These banks form part of the ALIDE which stands for ‘Association Latinoamericana de Instituciones Financieras Para el Desarrollo’. Most of the development banks are state owned or have a mix of public private partnership. Within the Latin America the Brazil has the largest no. of development banks present followed by Mexico, Colombia and Chile. The profitability of the development banks tends to be low and return of assets of these banks is lower than the private banks. This is particularly true for a country like Chile. Figure 5 Average return of assets on development and private banks in Latin America (Inter-American Development Bank 152) Figure 6 Development bank loans in Latin America (Inter-American Development Bank 152) 4 Other Financial firms The financial service sector of Chile is similar to that of the financial structure of the countries of Latin America. The main policy of Chile towards the operation of commercial banks in the country is regulating them and providing them high margin of profit in order to restructure the capital and repayment of the bail out loans in order that they have received from the Central bank of Chile. The main commercial banks that are operating in Chile are Santander, BBV and BCH. The commercial banks that are operating in Chile are very profitable and the capital adequacy ratios of these banks are also very strong and favorable. The main problem or the constraints of the commercial banks that are operating in Chile are the commercial banks are responsible for lending too much to the consumers and not lending much to the medium sized businesses of Chile that would have grown rapidly and creating new jobs for accessing more amount of capital. The number of depositors with the commercial banks is found more in number. The commercial banks of Chile are operating more than 47% of its activities in the banking sector of the country. The country has emphasized on the operation of their commercial banks for proving an opportunity to the depositors for the payment of money in definite mechanism. The two main or the important factors that determine the liquidity position of the commercial banks of Chile are they require the funds for fulfilling various legal requirements and settlement of the various obligations that exist between the banks and also in the interbank market (Simmons 573-602). V. Country’s Balance of Payment and Balance of Trade- Principal Sources of Exports, Imports, investments, and funds transfer. The balance of payment of Chile have been designed in such a way that due to the situation of recession prevailing in the economy, the increase in the foreign interest rates and an unexpected increase in the export rate has lead the monetary system to regulate the economy in order to fulfill the monetary and the fiscal target of the country. The international monetary fund have prompted Chile to export the goods that worth more than 18.5 billion dollar. Chile have applied strict and stringent monetary policy in order to maintain its monetary policies .The balance of payment have facilitated Chile in overcoming the crisis , solving the problem of inflation that is prevailing in the economy and stabilizing the fluctuations in the demand . The main export of Chile is Copper and it exports more than 60% of its copper to abroad which contributes to the GDP of the country. The main investments in which Chile is involved mainly includes the direct investment made from abroad, the portfolio investment that is made on assets and the portfolio investment that is made on the liabilities and the direct investment that is made in Chile and also the other investment that is made on the assets and the liabilities . The investment of Chile mainly constitutes around 1758 million dollar. Chile has experienced surpluses in its trade practices due to the increase in the shipment of copper and the other exports of Chile mainly include the processed foods and chemicals and also services. The primary imports of Chile are coal, gas, refined oil and also lubricants which constitutes more than 19% of the total import of the economy, machinery contributes around 9% and the cars, computers, mobiles and the other electronic equipments contributes around 8%. The total trade surplus of Chile is 998.83 USD million. The main trading partner of Chile mainly includes Brazil and United States and its other partners mainly include the countries such as Mexico, Colombia, Spain and Netherland (Nogee and Sloan 339-368). VI. Foreign Reserves In terms of monthly foreign exchange reserves of Chile the foreign exchange reserves of Chile decreased to 38032.40 million $ in February of 2015 from 39957 million US$ in January 2015. The average foreign exchange reserve of the country was 15303.51 million US$ from the period 1982 to 2015. The foreign exchange reserve of the country was the highest in the year 42302.70 million US$ 2013. The foreign exchange reserve of the country was the lowest in the year 1983 to the tune of 1998.90 million US$. The Central bank of Chile reports the foreign exchange reserves of the country. The foreign exchange reserves are the foreign assets of the country that are controlled by the central bank of the country. The foreign exchange reserves of the country are made in gold in gold or a specific currency of different countries. The assets of the central banks can also be in terms of the marketable securities that are determined in terms of the foreign currencies like the treasury bills, government bonds, corporate bonds and equities and foreign currency loans. The currency earns foreign reserves through export activities and the foreign reserves are spent in import activities. VII. Current Situation of the country’s currency The currency of Chile is peso and the currency is considered as the most popular currency in the exchange rate in terms of USD and it has been ranked high. The code that is used for the currency Peso is CLP. The Chilean peso has adopted the crawling peg currency system. The peso is pegged to the US dollar in terms of its fixed exchange rate. During the period of recession the currency value of peso was devalued and therefore different exchange rate have been adopted in order to adjust periodically the differences that existed between the internal and the external rate of inflation. Recently the Chilean peso has been allowed to float freely against the USD. But the Central Bank of Chile has restricted their right for intervening in this matter due to the excessive depreciation that existed. The exchange rate of Chilean peso that existed against the USD is 600 Chilean pesos in terms of 1USdollar at the end of the period 2014. During the period of 2011 to the period of 2013 due the appreciation pressure on Chilean peso, the central bank of Chile have introduced two main programs for purchasing of the foreign exchange and controlling the fluctuations in the exchange rate. These programs were initiated by the central bank in order increase the demand of the international reserves and to strengthen the position of peso in the economy. VIII. Risk those banks in the selected country face- such Currency, Political, Regulatory, and Crime The macroeconomic environment in Chile is pretty stable and is characterized by strong GDP and domestic demand. The breakdown of GDP also shows healthy figures. The inflation of the country that is denoted by CPI is also not very high and is within limits. The rate of monetary policy is also low. The Banking sector is characterized by strong regulations which lay the foundation of a strong banking platform. The 12 Chilean banks and 112 international banks operate in the market. The 5 largest banks in Chile together hold about 70% of the total loans. The loan sector has seen sustained growth. The credit quality is pretty good. The political situation of the country is quiet stable. The return on equity is quite attractive. The banks also have good capitalization and there are strict regulations in the banking sector that focuses on increase of the consumer protection. The Chilean economy is risky in terms of the fact that is vulnerable to external shocks. However the public finance part is quite healthy in Chile. Chile’s main export revenue comes from copper mining in the country. The country faced economic slowdown in the year 2014 due to decrease in investment in the mining sector and decrease in the household consumption levels. Preventing, Detecting and Eradicating Money Laundering and Terrorist Financing Chile have introduced and designed CAMEL which is an internal rating system it has been designed for fulfilling the compliance of the banks according to the Asset Management Liability regulations for supervising the internal control of the banks. This system has been designed and implemented for controlling the money laundering and other terrorist financing in the economy since money laundering is required to be restricted as it is considered as the serious crime which affects the social, political, economical aspects of the economy as a whole. Chile has adopted the Financial Action task force for fighting against the money laundering activities. Chile have engaged various supervisors and has adopted various measures for increasing the transparency, improving the cooperation among the cross border regulators and also the supervisors in all the areas for controlling the terrorist financing and money laundering activities. X. Important Bank Failures and Scandals in the Country Chilean economy has long been stable and there have been almost no banking failures in the recent years. The most recent bank failure to have occurred in the country can be traced back to 1982. The crisis of 1982 was one of the major economic crises to have occurred in Chile. It was worst in the history of Chile since the 1930s. It happened at a time when the country to moved away from the Andean pact to form a separate economic policy. The country pursued liberalization without having major regulations in place. In 1981 two banks were bailed out by the government of Chile. These included Banco De Talca and Banco Español Chile. A recent bank that has been engulfed in controversy and scandal in Chile is the Banco penta that is the investment banking unit of Penta group. The banco penta is involved in the scandal that involves suspected tax fraud and alleged financial funding of political campaigns. . Future Outlook for this Country and its Financial System The improvement in the economic development of Chile and also the development in the financial structure and the banking system of Chile has resulted in increasing the efficiency in the financial system of Chile. The Central bank of Chile has adopted a well managed and reformed policy for controlling and preventing the rate of inflation in the economy. The various measures that are adopted by the banking system in Chile will reflect the transparency in the foreign exchange and monetary policy in the economy which will result in the increase of credibility. The flexibility in the financial system will increase the prospect of the banking system of the country. XIII would you Approve Lines of Credit for Banks in this Country? The banking sector in Chile is quite stable and is governed by a good regulatory structure. This makes the financial system and especially the banks in the country pretty stable. The banking sector in this country is stable and is governed by a good regulatory framework which makes the sector ready for future challenges of growth. Many of these banks categorize as the safest in the Latin America as shown in figure 2 and amongst the safest in the world. In respect of these facts lines of credit is approved for the banks of Chile. Figure 7 list of top safe banks in Latin America (Cunningham) Figure 8 List of top Safe banks in the world (Cunningham) Works Cited Banco de Chile. Corporate Presentation. 30 June 2014. web. 4 April 2015.< http://ww3.bancochile.cl/wps/wcm/connect/a7909180455159c8b645bf8395200d6a/Banco-de-Chile-2Q14+Final.pdf?MOD=AJPERES&CACHEID=a7909180455159c8b645bf8395200d6a > Cunningham, Andrew. Awards: World’s Safest Banks 2012. 01 October 2012. web. 4 April 2015. < https://www.gfmag.com/magazine/october-2012/awards-worlds-safest-banks-2012 > Goldstein, Judith, and Lisa, Martin. "Legalization, trade liberalization, and domestic politics: a cautionary note." International Organization, 54.03 (2000): 603-632. Inter-American Development Bank. 2004. Unlocking Credit: The Quest for Deep and Stable Bank Lending. Washington: IDB. Morande, Felipe. and Matías, Tapia. “Exchange rate policy in Chile: from the band to floating and beyond.” Banco Central de Chile, 152.1 (2002): 2000-2010. Print. Nogee, Joseph , and John, Sloan., “Allendes Chile and the Soviet Union: a policy lesson for latin American nations seeking autonomy.”Journal of Inter-American Studies and World Affairs 2.1 (2000): 339-368. Print. OECD. Maintaining Momentum OECD Perspectives on Policy Challenges in Chile: OECD Perspectives on Policy Challenges in Chile. Chile: OECD Publishing. Print. Orozco, Ines. An Analysis of the Banking System Structure in Chile, Colombia and Peru in Light of the Creation of the Integrated Latin American Market – MILA Market. 1 April 2014. web. 4 April 2015.< https://www.stern.nyu.edu/sites/default/files/assets/documents/con_047195.pdf > Simmons, Beth , “The legalization of international monetary affairs.” International Organization, 54.1 (2000): 573-602. Print. Subercaseaux, Guillermo., “The Monetary System of Chile.” The Annals of the American Academy of Political and Social Science, 37.3 (2001): 105-128. Print. Read More