Bank reforms to increase cost of doing business in Ecuador

Bank reforms to increase cost of doing business in Ecuador

The cost of doing business in Ecuador is already high for extractive sectors. Investments in Ecuador’s financial services sector may face added obstacles following recently proposed regulatory measures.

Ecuador is a telling example of the Latin American growth narrative. An export-oriented economy, it has easily accessible and proven reserves of oil and various minerals, including gold. Its history is turbulent and violent, although much of the violence has occurred domestically and not on an international level. Most importantly, Ecuador resembles the story of Latin America in a political sense, where the democratically elected legislature and executive have failed to show accountability to the public and created an uneasy, fragmented and vulnerable political scene.

If successful, the proposed banking reform will make the political situation in Ecuador even more tenuous, as it would further disrupt commerce in an economy trying to stay competitive in international export markets and attract foreign capital.

The Ecuadorian government recently considered stricter regulations for its banking sector to the National Assembly. The current governing party has already successfully passed several laws restricting the financial sector. Since 2007, the return on equity for Ecuadorian banks has fallen from 24.2 to 10.2 percent and the Private Banking Association of Ecuador estimates that if the proposed measures are passed, profits will continue to shrink in 2014 as they did in 2013.

Granted, the global financial crisis of 2008 surely influenced the downward spiral of financial instruments. However, investment banks have largely recovered since then, and Latin American banks were not hit as hard as their North American or European counterparts.

In the Ecuadorian case, blame lies with the politics and not necessarily the markets. Regulations imposed over the past six years have included a tax on capital leaving the country, placing maximum fees on financial transactions, and the establishment of a domestic liquidity coefficient, requiring banks to hold at least 45 percent of their assets domestically.

The drop in profits in the financial sector has not been a sudden shock. Rather, the ruling party’s enacted regulatory laws have slowly but consistently weakened the banks. And the motive seems to be political. Rafael Correa, the leader of the ruling leftist party and president of Ecuador, pushed for a new constitution in 2008, which introduced an explicit agenda to further regulate banks. The constitution of 2008 also merges the central bank with the executive branch, significantly decreasing its level of autonomy. The executive’s political agenda can now directly influence monetary policy.

Continued protectionist control over the banking sector could harm the Ecuadorian economy. Ecuador has already suffered setbacks in attracting investment for its extractive industries, especially from the United States. Investment in petroleum has declined steadily in the past decade because of unfavourable economic terms, legal uncertainties and the overall tax policy.

Similar unfavourable economic terms that slowly drove away FDI from the petroleum sector might now do the same with the banks. Foreign investors entering the Ecuadorian banking sector are already coping with burdensome tax policies—they may also face political obstacles to growth in a once-healthy financial environment.

Categories: Finance, Latin America

About Author

Daniel Lemaitre

Daniel is a GRI Senior Analyst. He has worked in policy research centered on the political economy of the Andean region in the public, NGO, and private sectors. Daniel holds an MSc in Comparative Political Economy from the London School of Economics, concentrating on Latin American markets.