Analysts See Financial Sector Dollarization Declining in Mid-Term
According to a report by Business News Americas, the high degree of dollarization of the Costa Rican banking system is likely to decline in the medium term thanks to the country's new exchange rate regime.

On October 17, the Banco Central de Costa Rica (BCCR) - the Central Bank - moved to a crawling band exchange rate regime from a crawling peg one.

The crawling peg system, under which the Colón currency depreciated by a pre-announced gradual rate against the US dollar, kept the real exchange rate steady but built in inflationary tendencies, analysts said.

"As long as the band widens and volatility increases, one would expect a decline in the degree of dollarization of the financial system,"  according to consultant and former Central Bank president Rodrigo Bolaños.

Opinion is that the previous exchange rate regime led to the widespread dollarization of the economy, Bolaños said.

And high dollarization of balance sheets is one of the vulnerabilities of Costa Rica's banking system, said Jeanne del Casino, VP/senior credit officer at Moody's.

The key risks for the financial systems in highly dollarized countries have come from increased susceptibility to liquidity squeezes caused by unpredictable runs on bank deposits and an underpricing of credit risk. These have in several cases undermined the solvency of the banking system and destabilized economies, the IMF says in a document on financial dollarization in Latin America.

Even for people who do not earn their income in dollars, dollar-denominated financing is commonly available in Costa Rica, largely due to more favorable lending terms for dollar-denominated loans than for colón-denominated deals.

"Loan portfolios are highly dollarized. About 40% of total loans are US dollar denominated and although this proportion has been declining in the past few years, it still poses a risk to the Costa Rican banking system," said Felipe Brenes, technical manager at regional credit ratings agency Sociedad Calificadora de Riesgo.

However, banks have been trying to manage this risk, Brenes said. If a client does not get paid in dollars, he or she generally receives less financing from US dollar-denominated loans than from Colón-denominated ones.

Costa Rica's banking sector, excluding state-owned second tier mortgage bank Banhvi, reported assets of ¢6.82 trillion colones (us$13.6 billion) as of September 30, according to banking watchdog Sugef.