Latin America, for many years a continent beset by turbulent economic problems and an underdeveloped banking industry, has emerged over the past decade as an extremely promising region. This change comes at a time when regions that have driven world economic growth – namely the US and Europe – battle their way out of the serious economic problems of the past few years.
The banking industry around the world is undergoing fundamental change: new regulations are being implemented to prevent overly speculative practices, banks are being broken down or bundled up, and the industry is looking at how it can regain the trust of the general public.
While Latin America has faced its own challenges, it has also developed a stable and enticing banking industry, quite different to its European and North American cousins. Although the causes of the banking crisis in Latin America were very different to the more recent ones in Europe and the US, there are lessons that can be learned by policymakers trying to restructure the industry. One man with plenty of experience in all three regions is Conor McEnroy, Chairman of Paraguayan bank Sudameris.
We’ve really taken far too long to clean up the banks. They need to get their balance sheets cleaned up quickly
Having started his career in London more than 30 years ago, McEnroy has gone on to work across Europe, the US and South America. With plenty of experience in restructuring struggling banks – the latest example of which is his work at Sudameris – McEnroy is well placed to discuss the current banking crisis. He talked to World Finance about his experiences in restructuring banks throughout his career, what he feels needs to happen to get the sector back on track, and why Latin American economies – and particularly Paraguay – have so much potential for growth.
Emerging from the ‘lost decade’
McEnroy said that after the turmoil experienced in Latin America during the 1980s and into the 1990s – borne out of the political changes going on at the time – the continent had to get itself in order, starting with adhering to internationally agreed regulations like Basel I, which the rest of the world had been already been working with.
“Remember that Latin America went through what was called the ‘lost decade’, which was basically the countries coming out of dictatorship and coming into democracy, with management weaknesses coming to the fore. All countries across the board smartened up their regulators and took Basel I seriously,” he told World Finance.
Nowadays, the region’s banks are in a more stable environment, which is leading to steady growth: “Recently, restructured and re-regulated banks, and in particular bank ownership coming under increased scrutiny, has led to a fairly healthy system and a growing market. In a growing market you can afford mistakes. You have across the board – with the exception of basket cases like Argentina and Venezuela – strong banking systems.”
The restructuring of the industry was not without its false starts, however. Different models were pursued in different countries. During the 1994 Mexican banking crisis, the government took on the bad loans that banks had accumulated without any serious reforms or repercussions for the banks.
Chile, on the other hand, bailed out its banks but placed some strict regulations on the industry. McEnroy says that while it worked for Chile, that model might not be transferrable to other parts of the world. Instead, he points to Brazil’s strategy of simply “applying the rules of capitalism”.
Global banking crisis
McEnroy says that no matter how many times mistakes are made in banking, the cyclical nature of the industry means that eventually the same mistakes will be repeated: “Banking crises are not one-offs, but occur regularly. The question is how long is the frequency. If you go to Canada, I think it’s about 50 years since they had a banking crisis. In the US, you have a banking crisis certainly every 20 years, perhaps every 10, depending on your concept of a crisis.”
Reforming the industry is a matter of urgency, says McEnroy, and he thinks that in Europe and the US action hasn’t been taken quickly enough: “We’ve really taken far too long to clean up the banks. They need to get their balance sheets cleaned up quickly. I would be aggressive in saying that if the boards of the banks don’t understand why that is a matter of utmost urgency, then those boards need to be changed.”
A stronger regulatory environment is also essential in getting the industry back on track, and there should be a particular emphasis on making sure banks actually obey the regulations that are drawn up: “The key issue in restructuring would be that self-regulation does not work. Secondly, history repeats itself. There’s always another generation ready to come and make the same mistakes as the previous generation.”
Most important for the industry in Latin America is the separation of traditional banking institutions and other investment houses. McEnroy said it is this difference between Latin American banks and those that are in Europe and the US that has led to their comparative stability when looking at Latin America.
“The key difference is that the industry in South America is traditional, old-fashioned, plain vanilla banking. I believe that the downfall of banking in Europe and the US is driven by the issue of regulation, in particular commercial banks being allowed to be investment banks, and investment banks being allowed to act as commercial banks.”
He added: “Most regulators will not allow commercial banks or high street banks to be dabbling in what in Europe we call credit default swaps – so called to avoid regulatory supervision by the insurance regulator. South American banks wouldn’t be allowed to do things like that.
Looking at Europe, McEnroy is worried about the policies being promoted as the solution to the banking crisis: “One thing I find very disturbing is the new European rules on bank resolutions. As I understand from the press reports, bondholders are going to be treated equally to deposit holders. That’s fundamentally wrong. Anybody who understands banking will understand that that is wrong. This is an investment banker’s concept of a commercial bank.”
He said that this goes against the basic principles of banking, and that deposit holders should be the last to suffer the consequences of a banking collapse: “Under the rules of capitalism, the first guy to lose his money is the shareholder, the second is the subordinated debt holder, and the third one is the bondholder. After that, there is an unwritten rule that you cannot default on trade finance, because it’s bad for the country, as it will put up the financing costs of exports and imports tremendously.
“You also cannot sting bona fide deposit holders. It is simply wrong to treat the working capital deposit of a supermarket company the same as a professional investment manager taking a risk on a bond.”
He does feel, however, that some of the policies that have kept interest rates low in Europe and the US are having positive consequences for South American economies: “While the banking institutions in Europe and the US are practicing this low interest rate environment – primarily to help the banks and their clients finance their way out of their solvency issues – it has a knock-on effect in South America. There aren’t those solvency issues in South America. Suddenly South American yields are a little bit higher than in Europe or the US, so we’ve become very attractive and we can access long-term money. We’re on a little bit of a boom in terms of development capital – building factories, building infrastructure at very cheap historic rates for us.”
Depositors come first
McEnroy is passionate in his belief that a bank’s first responsibility is to its deposit holders, and that any speculative investment practices should be kept separate from the traditional activities of the bank. He asked: “What is the purpose of a bank? What is the role of a bank in society?
“In the first instance, it is a safe place for someone to deposit his or her money. There is no human or civil right of access to credit. The first responsibility of a bank is not to lend money, but to provide a safe place for a deposit, and then they lend money within that context. It’s easy to lend money, but it’s hard to raise deposits.” He added: “I strongly believe that the closer the shareholder is to the bank, the more prudent and conservative the bank will be.
History repeats itself. There’s always another generation ready to come and make the same mistakes as the previous generation
“Banks should be prudent and conservative, because their primary job is to provide a safe place for deposits. They are the de facto custodians of the payment system and they channel excess capital into development capital, for individuals or for business – the money to buy a house, build a factory, buy a machine, and so on.”
He added that maintaining a close link between the shareholders in banks and management should be key to sustaining stability. When the shareholder has less involvement, it is up to the manager to act on their behalf, as well as for the banks: “When the shareholder is absent from the bank, you’re relying on the manager to manage the money in the best interests of the bank and in the best interests of the shareholders.
“They’re automatically conflicting agendas, hence you need a board of governors separate from a board of managers, but it doesn’t work very well when the guy who’s going to feel the pain of the mistakes is far away. I think that’s one generic problem that we need to revisit in terms of regulation.”
Dealing with an ethical crisis
The lack of trust that now exists between shareholders and those responsible for managing their money has not always existed. Speaking to World Finance, McEnroy talked of his first day working on the floor of the London Stock Exchange many years ago, and the advice he was given by one of the senior brokers: “I met this broker who said to me he was going to bring me onto the floor. He turned to me and said, ‘Conor, I’m going to tell you the most important thing you will hear in your career. My word is my bond. That is the rule of this floor. You must never try to squirm out of your word. You must stand up and honour your word.” The difference now, according to McEnroy, is that trust has evaporated and now there is a requirement for constant scrutiny.
Another problem that has emerged in recent years is the cult of money, and the obsession that people have with becoming rich. McEnroy said that instead of employing people who claim to be able to generate huge sums, banks should hire those capable of ensuring stability: “We have come to admire people who make money, and have got to the point where we don’t ask and don’t want to know how they have made that money. This has crept into banking, and it’s very dangerous in the fiduciary business. In the deposit-taking business, you do not want the brightest and the brilliant managing your money, you want the reliable and the consistent. When you get overly creative people [who are] under supervised, bad things will happen. You’ll end up with rogue traders.”
Restructuring the fallout
Where the industry goes from here is a answer that McEnroy clearly feels strongly about. Many observers have called for large banks to be broken up and restructured, and McEnroy is well placed to discuss how this can be done. After many years of restructuring banks, McEnroy was approached by UBS with the task of reviving a small bank in Paraguay.
Sudameris was struggling to make a mark in the industry, but McEnroy saw this as an opportunity. How far a restructuring goes depends on the extent of a bank’s problems, but McEnroy believes that if a company is failing then the first people to be held responsible should be those at the top.
“When you have a dysfunctional company – and, in particular, a dysfunctional bank – you must start with the board. If the board has brought the bank to failure, then it needs to go home, because they were clearly not up to the job. You have to start at the top. If the board member does not have a deep understanding of derivatives, how can he pretend to be a board director, supervising this activity?”
At Sudameris, McEnroy chose to get rid of the old board and bring in a wide range of heavyweight figures from across the Latin American financial sector: “What we did was eliminate the board in its entirety, and we started again. I brought in quite a diverse collection of directors – former CEOs of banks in the region, including the former CEO of Nova Scotia in Chile, and a former head of Santander in Peru, Chile and Paraguay. I brought in a former regional director of the IMF, [and] three people who were either former chairmen of central banks in different countries or deeply involved with the regulators. I brought in the best minds.”
Getting each of these individuals on board took great powers of persuasion on McEnroy’s part due to the poor state Sudameris was in: “I went to each of them individually and said ‘don’t laugh, but I have this little bank in Paraguay. It’s bank number 15 out of 15. It’s $90m in assets, but here’s my plan. I’d like you to come on board and help me govern it.”
The responsibility of a board should be to govern the company and ensure that it is acting in the best interests of the shareholders, making appropriate provisions and monitoring costs. Nowadays, how a bank is seen externally is just as important as its internal practices, according to McEnroy.
“A board should be a governing body. It’s there to supervise, to set policies and give due benediction to tactics, and to protect the name and image of the bank. These days it has a special task, which is not only internal audit, but also compliance. We believe compliance should report directly to the board, because it’s such a sensitive issue.”
The responsibility of a board should be to govern the company and ensure that it is acting in the best interests of the shareholders
While a lot banks undergoing restructuring tend to get rid of many employees across the company, McEnroy said that at Sudameris there were plenty of good workers who simply needed stronger leadership: “Further down the ranks I found very good people needing direction, so we moved our surplus personnel from line to staff for projects and moved them back to line as the bank grew.”
Although many Latin American economies have experienced rapid economic growth since the turn of the century, Paraguay’s current level of growth of 15 percent surpasses them all and is drawing the attention of investors around the world. The country’s banking industry suffered a liquidity crisis during the mid-1990s, which led to the IMF and World Bank encouraging regulatory reforms and foreign involvement. The dominant sector, though, is agriculture, and it is this industry that has spurred the growth of recent years.
However, McEnroy cautioned that such high levels of growth are down to the country emerging from a serious drought, which is something it suffers from every decade: “About every 10 years there’s a drought. The pent-up investment demand of clients means that there was double the normal investment after the drought. Thus you have this phenomenal 15 percent GDP growth, which is so heady one would think the country has been on the beer for a year! Cut that in half, it’s still a spectacular level of growth.”
The agriculture sector benefits from a high number of products that Paraguay is able to export, such as beef, sugar, wheat, oats and soya beans. According to McEnroy, the country’s main export partner is Europe, followed by the Mercosur South American trade bloc. However, many of the Mercosur exports are re-exported.
He told World Finance: “You need to keep in mind that 30 percent of GDP is agriculture, which is phenomenally high. Paraguay has huge swathes of agricultural land and it’s under-utilising them tremendously. So it has a very bright future as a provider of protein, sugar and starch.
“That sector has the raw materials to grow. In the first level of the agricultural cycle, you’re shepherding animals. The next stage of development is planting cereals. In the third stage you’re doing horticulture with fruit and vegetables. We still have to get to that stage in Paraguay.”
Another facet of the country’s development potential is extracting the abundant natural resources it is thought to have. Although the industry is relatively young, a lot of work has been done to encourage foreign investment. McEnroy said: “Paraguay is only beginning to look for economic stone, precious and semi-precious metals, ores and hydrocarbons.
According to McEnroy: “The man who discovered all the copper mines in Chile thinks there’s the motherload of titanium in Paraguay. There are four campaigns of hydrocarbon exploration underway. It’s very early days though. The likelihood is that there are hydrocarbons. There are also enormous amounts of shale gas, as there are in other places. With precious metals, you have gold mines. There’s been a lot of reform in mining and minerals law, which is conducive to foreign investment. I would expect to see a lot more interest in exploring what’s under the ground.”
The country needs to focus on developing its infrastructure if it is to sustain its growth, and this is something McEnroy expects future governments to dedicate much of their efforts towards: “The big challenge for Paraguay is infrastructure. The country must connect itself seamlessly to the Chinese through good ports, which is the best future market for Paraguay. Europe and the US are also big markets. In any export-led economy, logistics and infrastructure is key. I understand that that is going to be the focus of the next government.”
For someone with such wide-ranging experience in many regions, McEnroy is confident that Latin America is one of the regions that will help drive the global economy for the next few years. Part of this is its banking sector, which he feels could teach those around the world a few lessons in how to emerge from a crisis.
He is more determined than ever to see the banking industry – around the world – return to principles of trust and responsibility that it practiced when he began his career.