IMF Highlights Potential Solvency and Liquidity Risks in Ecuador’s Banking Sector

IMF Highlights Potential Solvency and Liquidity Risks in Ecuador’s Banking Sector

The International Monetary Fund (IMF) has published an analysis of Ecuador’s banking and cooperative sector which aimed to identify potential risks these sectors may face due to an economic shock.

The study primarily focused on private banks and cooperatives, which constitute 81% of the sector’s assets.

Despite the economic shocks brought about by events like the Covid-19 pandemic, the report commends the resilience of private financial entities. However, it also raises a flag on potential solvency and liquidity risks that may arise from future economic shocks. This is mainly because these financial entities had to absorb losses from unpaid loans that increased during the pandemic.

Financial Relief Measures and their Impact

The report also highlights the impact of financial relief measures in the form of waivers, restructurings, and refinancing of loans. These measures have reportedly weakened the payment culture in Ecuador. In fact, Ecuador ranks second among seven countries with the highest percentage of overdue loans in the region, right after Peru.

Furthermore, the IMF report outlines challenges that the financial system could face between 2023-2025. These include a potential fall in oil prices, a slowdown in global demand from the US and China impacting Ecuador’s dollar income, higher interest rates abroad making it expensive for financial entities to access foreign loans, and political and social unrest posing systemic risk.

Results from IMF’s Stress Tests

As part of the analysis, the IMF conducted stress tests to evaluate the sector’s resilience under different risk scenarios. These tests revealed that if a mild or moderate risk scenario materializes, five small private banks out of 24 would fail to meet the minimum solvency percentage required by law. Among 96 large and medium cooperatives, 19 would also fail to meet this percentage.

Under a more adverse scenario, the solvency level would fall in nine banks, and about 35 cooperatives would also fail to meet the required minimum. However, the Association of Private Banks asserts that these test results should not unduly alarm the public as the overall system indicators remain healthy.

The Risk Landscape and Recommendations

The IMF report suggests that institutions with less diversified credit portfolios, primarily focused on consumer loans and loans for small and medium businesses, are the most vulnerable. In terms of unpaid loans, microcredit is the area with the highest default rate, reaching 7% in private banks and 8.59% in cooperatives in August 2023.

The IMF also projects potential liquidity issues for larger banks, representing 60% of the system’s assets. Under an adverse scenario, three out of six such banks would fall below the IMF’s reference Liquidity Coverage Ratio (LCR). While this does not imply insolvency, it does underline the need for the country to address these risks for banks to access more liquidity.

In conclusion, the IMF recommends that financial entities should have more options to strengthen their liquidity. Challenges to bolstering liquidity include the requirement for financial institutions to maintain at least 60% of their liquid assets in Ecuador and the obligation for private financial entities to maintain minimum investments in securities.