Fitch: Venezuelan Banks Resilient but Facing Growing Challenges

Private Venezuelan banks continue to report resilient loan quality ratios and earnings, even when adjusted for inflation. However, growing macroeconomic imbalances, high unseasoned loan growth and government policies that favor state banks pose additional challenges, according to a Fitch Ratings report.

'The banking system's significant exposure to the public sector, as well as a marked shift in portfolio composition toward more vulnerable economic segments and consumer loans, could lead to a sudden deterioration in asset quality in the event of a forced economic adjustment,' said Mark Narron, Director. 'Further government regulations and intervention could create additional challenges.'

In December 2014, Fitch downgraded the long-term Issuer Default Ratings (IDRs) of the seven largest private banks to 'CCC' from 'B,' in line with a downgrade of the sovereign. All these banks' ratings are limited by the sovereign given their vulnerability to the country's weak economic performance, high inflation and policy choices.

In addition to long-standing interest rate caps and floors and compulsory loan requirements, beginning in 2014, the government enacted policies favoring state banks. These included the migration of public sector deposits to state banks, and restrictions on private banks' ability to provide customers with access to hard currency. These actions led to one-off liquidity events, evidenced by spikes in inter-bank rates. However, in the absence of further government intervention, Fitch does not expect these policies to lead to a sustained divergence in deposit growth relative to state banks.

Venezuelan banks continue to rely on demand deposits for the vast majority of their funding, maintaining a large, negative mismatch between short-term assets and liabilities. However, this position remains manageable under Venezuela's current scheme of foreign exchange controls which acts as a barrier to capital flight.

The effects of inflation on operating expenses, plus an uptick in funding costs, led to weaker profitability and internal capital generation in 2014. In addition, the government's elimination of the inflation adjustment for the calculation of income tax will further pressure profitability in 2015. Weaker profits and high nominal asset growth in turn continue to pressure capital ratios. While capital levels vary across banks, Fitch expects that capitalization will deteriorate further if the rate of deposit growth does not decline.

Loan quality ratios have been stable but belie potential risks as they are distorted by inflation. The banking system's significant exposure to the public sector, as well as a marked shift toward more vulnerable economic segments and consumer loans, could lead to a sudden deterioration.

Many banks have continued to proactively increase reserves for impaired loans in order to better confront macroeconomic imbalances. Although reserve levels compare favorably with those of international peers, Fitch views them as potentially insufficient given the volatility in asset quality exhibited during past crises.