Moody's: Slowing loan growth to make Argentine banks more sensitive to inflation

A slowdown in loan growth at Argentina's banks because of a stagnating economy will make the banks even more vulnerable to high inflation, according to a new report from Moody's Investors Service, "Slowing Loan Growth at Argentine Banks Unmasks Inflation Challenges."

Moody's expects a 1% contraction of real GDP for Argentina in 2015 and an inflation rate consistently above 30%, which will hurt the banks' performance, raise asset quality risk, and result in a more difficult funding environment. "Although banks have been reporting very strong profitability, after adjusting for inflation, real profits have been much lower, and in many instances have even been negative," according to Moody's analyst Fernando Albano.

"Argentina's economy continues to weaken owing not just to persistently high inflation but also to the steady depreciation of both official and unofficial exchange rates, as well as the government's unorthodox policies. These factors have already led to declines in private investment and will only worsen this year," said Valeria Azconegui, a Moody's analyst.

Because of the weakening economy, loan demand, particularly from consumers, will decline. At the same time, the Argentine banks are also trying to rein in credit growth, by minimizing their exposures to riskier albeit more profitable classes of borrowers and increasing their holdings of liquid assets such as central bank notes, which are yielding negative real interest rates.

Moreover, operating expenses are growing and chipping away at banks' margins. To compensate for inflation, lenders have been forced to regularly raise employee wages, which constitute at least 65% of operating costs, but they will find it increasingly difficult to pass the cost of further wage hikes on to customers.

Government-mandated interest rate caps and limits on raising bank fees will also hurt margins, given that the banks have been forced to offer credit to both corporate borrowers and small and medium-sized enterprises at below-market rates, which further constrains profitability.

Because of inflation, problem loans will grow as borrowers' purchasing power declines and loan growth slows. Although inflation will lower debt burdens, rising unemployment and declining household wages will hurt borrowers' ability to pay down debt. If real disposable income shrinks more than real debt burdens do, asset quality will deteriorate. In addition, inflation will also continue driving up costs in the industrial sector, constraining job growth and economic activity, which will in turn lead to cuts in long-term investment plans, eventually fueling a rise in loan delinquencies. Delinquencies have already begun in the consumer loan segment, further suggesting that asset quality will weaken in 2015 and 2016.