Strong capital and liquidity levels leave DR banking industry in rude health

A buoyant economy is driving the strong performance of the Dominican Republic’s banks, with sector-wide profitability and asset growth rising on the back of solid consumer and business activity.

Boosted by strong capital and liquidity levels, most lenders are well-positioned for sustained growth as economic headwinds subside and opportunities in emerging sectors, such as renewable energy and logistics, expand.

This bodes well for a banking industry that already leads its local region by profitability, even as long-term challenges, including the threat posed by climate change and rising money laundering and financial crime risks, grow in complexity.

As of June 2024, Dominican banks had the strongest profits in Central America, with system-wide net income to tangible assets at 2.5 per cent, according to research from Moody’s Ratings.

“The strong bottom line results from high interest rates, which have unlocked the value of [Dominican banks’] large and rapidly growing low-cost deposit franchises,” says Susana Almeida Martínez, an analyst at Moody’s Ratings.

A swift monetary policy tightening cycle initiated by the Central Bank of the Dominican Republic (BCRD by its Spanish abbreviation), in response to a Covid-19 pandemic-era inflation surge, saw the base rate peak at 8.5 per cent by late 2022 through to May 2023, from just 3 per cent in late 2021.

Starting from July 2023, interest rates have eased to 6.5 per cent as of October this year, following a decline in inflation.

To accelerate the policy transmission mechanism, the BCRD deployed additional liquidity injections into the banking system from the middle of last year, to support businesses and households and deepen credit expansion.

Almeida says asset quality in the system has held up well in a higher interest rate environment, with system-wide non-performing loans sitting at around 1 per cent, thanks to “disciplined underwriting policies, relatively strong capitalisation levels and an effective regulatory framework”.

The sector’s Tier 1 capital ratio stood at 14.9 per cent by July 2024, according to the Superintendency of Banks, the Dominican Republic’s financial services industry regulator.

Nonetheless, hazards remain as consumer loans continue to grow rapidly among most lenders, and now account for 28 per cent of total loans, according to Moody’s.

The SB says that system-wide consumer loans expanded by 20 per cent year on year in August 2024, with Moody’s highlighting the potential for deteriorating asset quality in this “riskier segment” of the market as banks’ exposure increases.

Meanwhile, commercial loan growth is also strong, increasing by 12 per cent over the same period, according to the SB, as business activity in tourism, renewable energy, manufacturing and construction expands at a steady clip.

Dominican banks’ expanding assets and higher profitability go hand-in-hand with the growing sophistication of the banking market.

In July Banesco Banco Múltiple became the first lender in the country to execute a $10mn cross-border repo funded in Dominican pesos, in partnership with financial market development company Frontclear.

The transaction involved using locally issued, peso-denominated bonds from the central bank and finance ministry as collateral to secure US dollar liquidity, which was then swapped for Dominican peso funding with the assistance of The Currency Exchange Fund (TCX), which is backed by development finance institutions.

Daniel Baeza, Frontclear’s senior vice-president for sales and structuring in Latin America, says the regulatory and operational groundwork developed for the transaction is already driving change.

“We went from no repos in the Dominican Republic to almost $100mn in our books [in just a few months],” Baeza says. “Several global banks followed suit and concluded additional transactions. So, that is quite significant.” 

To facilitate the trade, Frontclear established new local custody infrastructure to secure the title transfer of both the collateral and cash through its wholly owned local subsidiary, FCC Securities. 

It also worked with the central bank to update the country’s regulatory code in 2023 to permit the use of collateral for repo transactions. 

Prior to this amendment, domestic banks were prohibited from posting collateral to secure any type of funding, effectively blocking access to international liquidity through money markets and other secured channels.

“The central bank recognised the importance of bringing fresh liquidity into the system, and the only way to accomplish that is through the use of cross-border repos,” Baeza explains. 

He adds that the implications of a growing cross-border repo market will be profound, not least as the banking system looks to build its resilience against extreme weather shocks and support climate-related projects in the country.

“It has everything to do with climate finance because it forms the foundation for all other types of transactions that will be traded,” he continues. “If the money market — which is the short end of the curve — isn’t fully functional, then forget about doing derivatives or long-term financing.

“Local banks will be better equipped to expand their loan portfolios, manage risk more effectively, and utilise their bond portfolios more efficiently.”

It comes as the country’s banking system and private sector face growing threats from climate change and extreme weather events. 

In its latest Country, Climate and Development Report on the Dominican Republic from November 2023, the World Bank cautions: “Climate change poses risks to the financial system such as the banking sector’s heightened credit exposure to tropical cyclones and droughts.”

The World Bank reckons that damages stemming from tropical cyclones are expected to triple between 2021 and 2040, and approximately 21 per cent of banks’ credit-at-risk will be exposed to these deteriorating conditions, stemming from strong winds.

In particular, it notes that mortgages account for about 18 per cent of total banking sector credit and that a “significant portion” of these facilities are allocated to provinces with “high expected physical damage”. 

Almeida from Moody’s agrees and says the hazards facing the country’s banks are high. 

The rating agency assigns an issuer profile score of 4 (out of 5) for the Dominican Republic, reflecting its assessment of the country’s exposure to environmental risks and their impact on credit risk. This represents the second-highest level of environmental risk for the country’s banking system.

“We believe that banks in the Dominican Republic face significant environmental risks, primarily due to their direct and indirect portfolio exposure to physical climate change and water issues. The banks’ location and operations in the [country] make them vulnerable to natural disasters.”

Mobilising greater public and private investments in adaptation and resilience measures will be needed to tackle these challenges, alongside technical assistance. 

Alexandria Valerio, World Bank Representative for the Dominican Republic, says the organisation has been actively promoting climate financing ecosystems in the country to address these vulnerabilities. 

“There are various initiatives geared towards helping the private sector understand and manage climate change risks,” she says. 

Valerio says this includes partnerships with the central bank and ministry of finance, among other public agencies, to provide climate-centred technical assistance and to help assess climate-related risks.

“Over time, these efforts will enable the domestic banking sector to play a larger role in addressing the country’s climate-related needs by building institutional capacity, enhancing financial resilience, and promoting sustainable investment practices,” says Valerio.

Meanwhile, the World Bank also contributed to the development of a national Green Taxonomy Framework, which was approved in June 2024. 

This follows the launch of a national green bond framework by the capital market regulator in 2020, which enabled Banco Popular Dominicano to secure regulatory approval for the issuance of 2.5bn pesos ($41mn) in green debt securities in 2023.

As the country’s largest private lender, the bank entered the market for the first time in May 2024 with an initial tranche of 300mn pesos, aimed at financing and refinancing green loans.

Banco Popular has also been active in financing renewable energy projects in the country, and says that together with its subsidiary in Panama, its financing reached an approved amount of $450mn by the end of 2023.

State-owned Banreservas, the country’s largest lender by total assets, is also extending green financing solutions to the broader economy. 

This includes loan options through its “Renueva Verde” programme for solar panels for both households and businesses, and financing for electric and hybrid vehicles such as cars, scooters and electric bikes. 

Banreservas is also deploying its financial muscle to support big-ticket projects. 

In June, the Inter-American Corporation for Financing Infrastructure, an organisation backed by private sector and multilateral lenders, said it structured $322mn in long-term financing for the ongoing development of the Dominican Republic’s Siba thermal power plant, with Banreservas contributing $60mn as part of a syndicated loan. 

Beyond these climate-related risks, the Dominican Republic’s banks are facing other challenges. 

In particular, the growing threat posed by money laundering and terrorist financing networks is on the rise, as organised criminal groups linked to drug trafficking networks between South America and the US and Europe grow their presence across the country.

This problem is being compounded by a deteriorating security situation in Haiti, where gang activity has increased and deepened cross-border criminal threats for the Dominican Republic. 

Together, these challenges are complicating the ML/TF risk environment facing public agencies and the financial system alike. 

“Dominican authorities seized a record annual high of over 22 metric tons of cocaine in 2022, largely owing to explosive demand in Europe,” says Christopher Hernandez-Roy, deputy director and senior fellow, Americas programme, at the Center for Strategic and International Studies, a think-tank based in Washington DC. 

“But organised crime in the Dominican Republic is also involved in trafficking in persons, and money laundering, often connected to the country’s tourism destinations and casinos,” Hernandez-Roy says. 

He points to the Dominican Republic’s rising scores on the Basel Anti-Money Laundering Index in recent years, which measures the risks posed by money laundering and terrorist financing in specific jurisdictions. 

“Greater profits from the increasing cocaine trade to Europe necessarily means there is more money to launder,” he says. 

The authorities have taken an active approach to combating these risks, and Hernandez-Roy says an inter-institutional taskforce against money laundering was launched in 2023 to tackle organised crime and dirty money with support from the US Department of State. 

In October, the Dominican Republic also hosted the third Latin American Congress on the prevention of money laundering and financing of terrorism. 

The IMF says the Dominican Republic is also working on bolstering the AML/CFT readiness of the country’s credit and savings cooperatives, with new legislation currently being drafted to pull them into line with international best practices. 

The IMF also expects an updated national risk assessment to be published before the end of 2024, with the last available version covering the period from 2017 to 2020. 

These developments have been followed by several high-profile news cases, including instances of money laundering and financial crime in the Dominican Republic, hitting the headlines in recent months. 

Looking ahead, banks in the Dominican Republic are well-placed to handle these and other difficulties over the coming year.

Most analysts think sustained economic growth will see continued balance sheet expansion and an uptick in profitability, as favourable conditions lift the performance of leading institutions across the banking system. 

Encouragingly, much of this growth is likely to be dispersed across the consumer segment, as well as a mix of business sectors, ranging from tourism, to construction, to manufacturing, permitting loan book diversification. 

These conditions should quell any concerns over asset quality deterioration, while giving Dominican lenders the space to tackle other challenges, including relatively low efficiency levels relative to Central American peers, according to Moody’s.