Costa Rica’s Banking System Exposed to Currency Risks

San José, Costa Rica - The Costa Rican banking system is vulnerable to currency risks due to its large foreign exchange (FX) position and unhedged liabilities in the household and corporate sectors.

Vulnerabilities in the Financial Sector

According to a recent report by the Bank of Costa Rica (BCCR), the following vulnerabilities pose a risk to financial stability:

Large FX Position: The banking system has a long FX position, which increases its exposure to currency fluctuations.
Unhedged Liabilities: A significant proportion of foreign currency credit extended to the private sector is not hedged against exchange rate fluctuations, increasing the vulnerability of borrowers who do not generate income in foreign currency.
High Dollarization: The low profitability and high dollarization of the banking system pose a risk to financial stability.
Growing Household Leverage: The growth in household leverage increases the risk of financial instability.
Sovereign Exposures: The reliance on foreign bank funding raises concerns about rollover risks.

Impact on Financial Stability

A significant depreciation of the colon could affect asset quality and financial stability, according to the report. The data shows that:

Proportion of Foreign Currency Credit: The proportion of foreign currency credit over total credit extended to the private sector has been growing steadily over the years, with a significant increase in recent years.
High Inflation Rate: Costa Rica’s high inflation rate and potential for currency depreciation increases the vulnerability of borrowers who do not generate income in foreign currency.

Action Needed

The authorities have acknowledged that currency mismatches in the private sector pose a key risk to financial stability. The BCCR is closely monitoring this situation from both the banks’ perspective and the borrowers’ perspective. To mitigate these risks, policymakers need to take action to:

Reduce Foreign Bank Funding: A reduction in foreign bank funding could lead to a significant reduction in credit in Costa Rica.
Implement Risk Management Strategies: Banks should implement risk management strategies to hedge against exchange rate fluctuations.

Additional Information

In related news, the BCCR has announced that there are currently two state-owned banks operating in Costa Rica: Banco Nacional de Costa Rica and Banco de Costa Rica. However, one of the state-owned banks, Bancrédito, is no longer active in retail banking after its failure in July 2017.

The full report can be accessed on the BCCR’s website.