When multinational corporations come to the Dominican Republic, they arrive with references from their home corresponding bank.

“In the beginning, they do not borrow money,” says Juan Jose Arteaga, executive vice-president at Grupo Progresso, a Dominican bank. “They know they can do business with their own international banks, such as Citibank or Canada’s Scotiabank. But as soon as they are established here and have a statement, they can come to the Dominican Republic banks and borrow money.”

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Banco Progresso does considerable business with US, Canadian, French and UK companies – whoever wants to do business, as long as they come with a referral. “Banco Progresso has every offering in the basket available today. We are the only American Express representative in the country,” Mr Arteaga adds.

Some banks are even starting to offer euro accounts, in addition to accounts in US dollars and the local currency.

DR-CAFTA impact

No-one can say with certainty what impact DR-CAFTA will have on the Dominican Republic’s banking sector. Many believe it will not result in much change. But Mr Arteaga insists “It will be an open market and you have to be more competitive. The country is trying to reform.”

And he is optimistic for the future. “The banking industry is now stable, and we expect good things from the trade agreement,” he says. “This country has a lot to offer: good labour, excellent tourism options, and improved facilities and infrastructure.”

As the Dominican Republic emerges from the fiscal and financial crisis it suffered almost two years ago, institutional changes are under way to ensure the country’s banking system is solid.

“Congress put through fiscal reforms as soon as possible since it was critical to DR-CAFTA,” says Mr Arteaga. “Local people are regaining trust in their native banking system.”

Reducing barriers

When DR-CAFTA was signed into law by the US in August 2005, its goal from the US perspective was to reduce barriers to US trade, but the knock-on effect in the other signatory countries is the introduction of reforms in the domestic legal and business environments. These reforms, in turn, help to install confidence in these markets; such is, or will be, the case of the Dominican Republic’s banking and financial services system. A stable banking sector is seen as key to encouraging development and investment from both inside and outside the country.

Although the Dominican Republic has mostly recovered from the shock of the fraudulent accounting and embezzlement scandal, the fallout was nevertheless considerable, with the exit of three Dominican banks from the market, and a loss of confidence in the banking system.

John Schroder, a former New York City banker who now lives in the Dominican Republic and works as an independent consultant to the banking and securities industry, is convinced that the industry was always solvent and that reports in the press of an actual banking crisis were inaccurate.

“What did happen was Banco Intercontinental (Baninter) played politics with the previous government and gave president [Hipólito] Mejía and his staff each a $50,000 line of credit,” he says. “They abused it and did not pay the money back.”

The Mejía Administration ordered the prosecution of Baninter executives and immediately jailed them, having accused them of money laundering.

At the time, the banks were flooded with money in peso deposits, so were offering savings rates at 24% tax-free. “Instead of investing their money, people kept their money in the bank to earn the tax-free income,” Mr Schroder says.

Policies were not due to a corrupt banking system, he maintains. “It’s never been easy to get a banking licence in this country,” he points out. “But what changed because of public perception was the reserve requirement at the central bank.” The central bank was requiring banks to put in a 10%-15% higher reserve on an amount of money that would not earn interest. Some of the banks, such as Banco Mercantil and Bancredito, did not see that as being worthwhile so they closed their business in the Dominican Republic and were sold.

Some reports suggest that failed Banco Mercantil and Bancredito were owned by prominent Dominican families who had made extensive non-secured loans to other family-owned firms. Whatever the case, what resulted was a run on the banks for fear that other banks would also shut their doors.

Central bank steps in

With depositors unable to access their money, and the banks themselves having a history of not paying their insurance premiums, the central bank guaranteed all deposits would be repaid. “No-one lost any money,” says Mr Schroder.

But to cover 100% of depositors’ losses, the government issued central bank certificates of deposit redeemable in one year. This action pushed up national debt from the equivalent of about 18% of gross domestic product (GDP) to the equivalent of 54% of GDP. Consequently, the peso became severely devalued. The removal of the three local banks, in short, cost the Dominican Republic some 20% of GDP, accounting for more than $2.3m.

To avoid further damage, the government negotiated a stand-by agreement with the IMF in August 2003 to help cover the costs of the failures. The IMF involvement required that extensive changes in laws and procedures be made to the Dominican Republic’s banking system that included supervision and a general audit by overseas banking specialists. The IMF also required passage of a law setting procedures for cases of systemic risk to the banking system. These changes have been made, although not all have been fully implemented with appropriate regulations.

The crisis did, however, result in the country holding new elections that removed its president and replaced him with a new one. “But everything is quiet now, and we are continuing as usual,” says Mr Arteaga.

Although IMF involvement in the Dominican Republic officially ended during the 1996-2000 first administration of president Leonel Fernández, the institution is still on the scene to help maintain the banking industry as the nation works through the requirements of DR-CAFTA.

“Things are going well,” says Mr Arteaga. “President Fernández has asked the Congress to put through fiscal reforms as soon as possible, which is important for the DR-CAFTA agreement. These reforms are necessary if we are to be competitive with other countries. The new regulations through the superintendent of banks are very strict. But the banking industry is currently very stable.”

With the country’s economy stable once again and inflation low, currency rates are level with the exception of the predictable dip in the Dominican Republic peso-US dollar exchange rate between the US Thanksgiving holiday and Christmas. This is the result of Dominicans who live abroad wiring transfers from the US to their families at home, as well as money that arrives via tourists visiting the island to escape the winter cold.

“We have a colony of over one million Dominicans who live in New York and usually come here to spend Christmas,” Mr Arteaga adds.

Local banking

Mr Schroder says that most of his clients do their banking in the Dominican Republic, a good indication that investors’ confidence is returning. “There are no unnecessary restrictions,” he says. “They can easily wire money in and out.”

Add to this the fact that interest rates are diminishing. Savings accounts earn about 7%. Business loans for large corporations hover at 15%-17%. Interest rates for car loans are 20%-21%, compared with 2004’s rates of 30%-40%.

“Interest rates have really gone down. This helps to reactivate the economy as well,” Mr Arteaga says. “Besides, to request a loan now, you must be very transparent. The statement that you present to the bank has to be the same data that is reported to the internal revenue service. Your repay capacity has to be shown on the statement. Before, we knew the people and company, knew they had the capacity to repay and we lent them money. There is much more paperwork involved now.”

Stiff competition

Various banks on the island have become very aggressive in their efforts to attract new business.

“Other banks are also looking to come in because of freer trade agreements,” Mr Arteaga says. “We can expect a very active and competitive banking industry in the future.”

Banco Rio from Argentina is one new arrival, for example. Others are taking a hard look at the country. “Traditionally, foreign banks have not seen the Dominican Republic market as a large enough market for their business,” notes Mr Schroder.

While all banks in the Dominican Republic today offer basically the same products, what is changing is how they improve their services and treat their customers.

“In today’s world, you have to know whether or not your customers will do their business by telephone, internet or in person,” Mr Arteaga says. “Every day you must come out with new ideas on how to address your customers’ needs.”

With renewed confidence, business is already on the rise. Exports and business in the Dominican Republic’s free zones are now doing well, although everyone is waiting for further legislation to make the country more competitive for international trade and FDI. At the heart of some debates is the impact that the elimination of tariffs will have on the government’s budget.

Tax reform

“Fiscal reforms such as this will have a large impact when DR-CAFTA is in place,” says Julio Ortega Tous, chief debt negotiator for the Dominican Republic. An exchange rate tax – which is the third largest income source to the government, established by the central bank and collected within the Republic’s Customs system – will also be eliminated to comply with DR-CAFTA. Together, these taxes comprise 3% or $900m of GDP.

“If these taxes are not eliminated, the Dominican Republic cannot be eligible to start the process of free trade with the US and other nations in the DR-CAFTA,” Mr Ortega says. “We are already in discussions with Congress to replace these with an internal consumption tax/revenue excise tax on some products, or value added tax (VAT). But the debate is, we are replacing sources of income that are certain with one that is not so guaranteed in regards to the amount.”

Another major challenge facing VAT is the cascading effect it has on taxes applied. “The final reform needs to be 3.5% of our GDP from new sources to replace the income lost to meet our 2006 Budget,” Mr Ortega says.

More broadly, there is general agreement that to meet its goal, the Dominican Republic must be prepared to become more productive in participating in global trade. Banking is an important element of that effort.