Spanish banks' advantage
It is interesting the lack of interest at an international level about the process of privatisation of Latin American pension systems.
This financial service area has a client base of 40m with $80bn under management in eight different countries. But the economic and social advantages of these systems are not sufficiently explained both at regional and domestic level.
This could be due to the novelty of the system, since the forerunner is the 20-year-old Chilean system, and the others have only been running for six to seven years.
But in spite of this, the system has already achieved maturity and its economic advantages - reduction of public debt, development of capital markets - are a fact.
It should also be mentioned that the social evolution empowers workers with a more just distribution in the capitalisation system than in the old system, providing them with insurance cover in the event of death or serious disease and granting spending power and security in old age. Moreover, this evolution sheds a clearer light on the workplace situation.
This system has been quickly consolidated through its obvious advantages and the competitive nature of the market. The privatisation processes have been rather homogeneous. One of their main features have been the fast distribution of the market between domestic and foreign entities that were attracted by the new operations.
Taking part in this market split implies a strong investment in administration, IT, sales networks and marketing. The pension provision business has a moderate but consistent income. As a result, it is crucial to possess a secured client base that will absorb the important fixed costs that derive from administration and the redemption of the costs involved in setting up the business.
This, and taking into account the economies of scale that size provide, has led to a market concentration where four or five companies hold between 70% and 85% of the market share. This concentration process is not finalised yet and it involves mainly foreign investors, particularly Spanish banks. It has been achieved via strategic takeovers and mergers of existing operations.
In the initial stage, just after privatisation, marketing and acquisition of marketshare become the main goals. In its mature stage, the emphasis shifts to the quality of service and return of investments, both elements of great interest to the clients.
Some markets are still recovering from the exacerbated competition that prompted a significant reduction of returns due to commercial costs and expensive marketing campaigns.
The Spanish banking sector is in a strong phase of change like the rest of Europe, evolving from the high domestic orientation of both banks and ‘cajas de ahorros’.
The banking business is changing towards a model where the income source will derive from service provision rather than financial mediation, from branches rather than back-end management, from ATMs, online services, etc… Moreover, the EU is setting new rules with a different conception of financial services that ultimately aims at standardisation. Consolidated banking markets with large size players makes expansion more difficult.
Due to domestic saturation, Spanish banks have turned to Latin America for expansion, in order to keep up with the European competition. Latin America is the obvious choice because it has markets with great growth prospects and ready for technological change which are also culturally, historically and linguistically attuned to Spain.
These similarities are missing with the rest of Europe and this, added to the fact that acquisition prices are lower in Latin America, make European expansion just a second priority for Spanish banks. Spain has become the main investor in Latin America, not only in banking but overall.
At first, the international market presence was focused in the banking sector. Generally, the takeovers were businesses with high marketshare and top rankings in each country. Some of the financial business had been actively involved in the privatisation process and had already experience in the field.
Fund management was the preferred choice for several reasons. It was a low-expenditure, low-risk activity that suited the banking model where risk is the foremost element in decision-making. On the other hand, pension funds are a compulsory cumulative-savings operation, and therefore, the margins are recurrent.
Privatisation turns pensions into a regular financial service that, however, is compulsory for millions of people. This volume of business requires the management and processing of big databases, at which banks usually excel.
The cumulative savings turn into investments, and this activity becomes an asset management operation where banks bring added value. This value increases if we take into account the current situation in all markets, where the demand surpasses the offer of investment solutions, turning as a result to more experienced foreign banks.
Usually, customers answer in surveys that the most valued qualities of a fund management company are “security and financial backup”. This is a reasonable answer as they are allowing their pension capital to be managed, especially considering the past bad experiences in the financial sector of some markets.
The high level of market penetration of Spanish banks has positively affected the perception of the banking sector in terms of solvency and credibility. The technological changes have also been very positive. It has benefited both businesses and the drive towards fair competition, raising the standards to those of highly industrialised countries.
The involvement of banks in fund management is a natural development as well as complimentary to banking and insuring activities which appeals to other foreign banks, but there is the issue of a high concentration of the market. It is nigh impossible to reach a good niche in the market via takeovers since the valuations are too expensive. Operations of merging and takeover shouldn’t be overlooked, although the main players will be the existing fund management companies seeking to cut down costs through economies of scale.
The pension system depends on the social and economic evolution of each country. One of the main problems of the system is the so-called density problem, calculated dividing the amount of paying clients by the total amount of clients. This ratio shifts from 43 to 55, which means that for every 100 customers there are either 57 or 45 customers that don’t pay fees on a regular basis but who have managed funds and, in some cases, insurance cover.
The level of development of each country sets the standards for the legalisation of the rogue economy, the income growth of pensions, and therefore managing fees, and the percentage of self-employed.
Another significant element is demographics. Like in Europe, there is a marked trend towards a decrease in the birth rate and an increase in life expectancy. An aging population results in a smaller quantity of new workers and an extension of the working years span.
The countries that still have a hybrid system will be forced to transfer workers from the public to the private sector, since the public debt won’t be able to finance the cost and the private sector will offer a better and clearer management. Since these pension systems are quite recent, the laws concerning investment management are very strict. As the markets of capital develop and the legislation becomes more relaxed, there is scope for wider investment management. The funds will open up to other financial solutions, it will be possible to choose several investment portfolios and there will be more foreign investment.
All this plays to the banks’ advantage, since they have the expertise and the skills to manage assets.
There are already some countries with privatisation blueprints for private pension markets and others with such planned in mid-term. The reforms are now primarily focused in the Dominican Republic, Central America, Venezuela and Brazil.
The last two countries are rather important due to their size. In both, Spanish banks are already present. In Venezuela, the market share of Spanish banks is also remarkably high. In Brazil, although the pension system has not been privatised yet, there is a private pension scheme that is equivalent in size to the volume of managed funds in the rest of Latin America.
If the public system was privatised, the market would be gigantic and it would be different to the other countries in that the marketshare of Brazilian banks is considerably bigger than that of Spanish banks.
It can be imagined that the psychological and legislative block in the provision of financial services in Latin America will be eventually lifted to blur the boundaries between banking, insurance, pensions and mutual funds.
These boundaries don’t exist in the demand’s side, the consumer wants good service at good prices from an established brand.
This is the way forward for Spanish financial entities.
Javier Palacios is director for Latin American Pensions Funds at BBVA in Madrid