Inflation and banking results

ENRIQUE MARSHALL Director Master in Banking and Financial Markets PUCV, former Vice President of the Central Bank

Henry Marshall

I commented in a previous column on the havoc that inflation is wreaking. These are many, but this time I would like to focus on one of them, which is its impact on the banking results.

It is well known that inflation is bad for everyone – households, companies and banks – because it alters the functioning of the economy, distorts prices and economic signals, causes unwanted redistributive effects and reduces growth prospects.

“The sudden and/or unexpected acceleration of inflation, such as the one that has occurred in recent times, tends to swell the profits of the banks.”

However, in the short term it can generate apparently positive effects for some groups or sectors of activity. Those who see their prices or wages rise more quickly than the rest, perceive or, rather, misperceive a small advantage, even if it quickly reverses or vanishes.

But let’s stop at the banking sector. Sudden and/or unexpected acceleration of inflation, such as the one that has occurred recently, tends to inflate your earnings. The opposite occurs when inflation slows down abruptly or is negative, as has happened on more than one occasion in the past. These movements are very directly related to the nature of its activities and, above all, to the structure of its assets and liabilities.

In Chile, banks have a significant fraction of their assets in UF, which are well protected against inflation. But, not only that, they normally have more assets than liabilities in UF, which generates a positive effect when inflation accelerates unexpectedly and a negative one when the opposite occurs.

In addition, banks maintain, among their liabilities, sight deposits for which they do not usually pay interest, but which can be invested in various uses and generate income, even though these only represent compensation for past inflation. As a result, their profits tend to grow when inflation is rising and shrink when it is falling.

On the other hand, the accounting rules in application, by not contemplating the monetary correction, as was the case decades ago, tend to swell the results in a context of high and unexpected inflation. A recent publication by the Association of Banks illustrates this point well, pointing out that the real or effective profitability of the sector would be significantly reduced, from 18% to 10%, if the corresponding adjustments or corrections were made.

At least two important conclusions flow from this analysis. One is that the correct interpretation of bank profits must be made with a medium-term perspective, subtracting the impact of sudden changes in inflationary dynamics. The other is that current accounting standards can lead to distortions in financial statements when inflation reaches double-digit levels, as currently observed.

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