THE WORLD BANK GROUP CHILE FINANCIAL SECTOR ASSESSMENT PROGRAM October 2021 TECHNICAL NOTE COMPETITION IN THE FINANCIAL SECTOR Prepared By This Technical Note was prepared in the context of a Finance, Competitiveness, and joint IMF-World Bank Financial Sector Assessment Innovation Global Practice, Program (FSAP) mission in Chile during August 2021 WBG led by Charles Cohen, IMF and Miquel Dijkman, World Bank, and overseen by the Monetary and Capital Markets Department. IMF, and the Finance, Competitiveness, and Innovation Global Practice, World Bank Group. The note contains the technical analysis and detailed information underpinning the FSAP assessment’s findings and recommendations. Further information on the FSAP program can be found at www.worldbank.org/fsap. CHILE CONTENTS Executive Summary ................................................................................................................................................................. 4 A. Introduction ..................................................................................................................................................................... 9 B. Market Characteristics, Dynamics, and Outcomes .........................................................................................13 C. Interventions that shape market dynamics .......................................................................................................29 I. Institutional and regulatory framework ....................................................................................................29 II. Competition enforcement: regulatory and institutional aspects ......................................................32 III. Financial regulation and infrastructure .....................................................................................................35 D. Appendix ........................................................................................................................................................................42 Figures, Tables and Boxes Figure 1: Assessing competition in the financial sector ..........................................................................................12 Figure 2: Concentration in the banking sector ...........................................................................................................15 Figure 3: Entry, exit and mergers of financial intermediaries ...............................................................................16 Figure 4: Market share dynamics 2015-2020 ..............................................................................................................17 Figure 5: Credit card market ..............................................................................................................................................18 Figure 6: Financial conglomerates...................................................................................................................................19 Figure 7: Profitability ............................................................................................................................................................22 Figure 8: Cost efficiency ......................................................................................................................................................23 Figure 9: Interest margin ...................................................................................................................................................24 Figure 10: Lending rates ......................................................................................................................................................26 Figure 11: Key questions on the intersection and interplay between competition and regulatory legal framework and institutional setup in the banking sector ......................................................................................30 Figure 12: Card Schemes ....................................................................................................................................................38 Table 1: Structure of financial intermediaries .............................................................................................................13 Table 2: Advocacy and enforcement activities in LAC peer countries...............................................................35 Box 1: WBG Assessment of competition in retail banking services in LAC .....................................................10 Box 2: Analyzing the fall in lending rates .....................................................................................................................27 Box 3: Legal and institutional frameworks for competition policy in the banking sector .........................29 Box 4: Competition advocacy initiatives in the Chilean financial sector ..........................................................33 2 CHILE Glossary CC Casas comerciales CCAF Cajas de compensación y asignación familia CMF Comisión para el Mercado Financiero D-SIFIs Domestic Systemically Important Financial Institutions FCIC Conditional Financing Facility for Increased Loans FNE Fiscalía Nacional Económica FOGAPE Fondo de Garantía para Micro y Pequeños Empresarios FSAP Financial Sector Assessment Program FSI Financial Soundness Indicator FyL Entidades que otorgan factoring y leasing HHI Herfindahl-Hirschman Index LAC Latin America and Caribbean MSME Micro-small and medium enterprise NPL Non-performing loan PSP Payment System Provider RIA Regulatory Impact Assessment RoA Return on Asset RoE Return on Equity SAG Sociedades de Apoyo al Giro SOE State Owned Enterprise SOFI State Owned Financial Institution TDLC Tribunal de Defensa de la Libre Competencia 3 CHILE EXECUTIVE SUMMARY1 Despite increasing concentration, falling interest margins and lending rates point towards a certain degree of price competition. Competition and contestability in the financial sector are conducive to important policy objectives in the financial sector, such as innovation, efficiency, and financial inclusion. In Chile, concentration indicators have increased for credit and deposit products over the past five years but remain below those of most Latin American and international peers. The increase in concentration came on the back of several high-profile merges and market exits that reduced the number of banks operating in Chile by one-quarter since 2015. Mergers were also the main driver of market dynamic as only few banks managed to significantly increase their market share through organic growth. However, profitability indicators of Chilean banks are relatively low and large banks are not significantly more profitable than their smaller competitors, suggesting that large banks are incapable to use their market position to generate surplus profits. Further, while credit kept growing until the onset of the pandemic, net interest margins as well average lending interest rates2 have declined significantly over the past years, particularly for mortgages and commercial loans, and are below levels seen in most peer countries. The decline in lending rates cannot be fully explained by variations in risk, inflation, funding costs or monetary policy and thus suggests that competitive dynamics played a role. Most customers have accounts or loans with more than one provider, pointing towards consumer power to choose and switch across different banks. To further facilitate customer mobility and price competition among lenders, authorities have recently passed legislation aimed at enhancing loan portability and reducing administrative and cost impediments to switching. A diverse set of non-bank lenders shapes dynamics in the retail credit. As the extension of credit in Chile is not restricted, several non-bank lending institutions exist, which cater primarily to lower income households, and SMEs. The set of non-bank lenders includes credit unions, factoring and leasing companies, credit card issuers linked to large retail stores (casas comerciales) as well as cajas de compensacion de asignación familiar (cajas de compensación), private, non-profit entities created by law that administer social security benefits but also grant so-called ‘social credit’. While these entities are small in terms of total assets -and the recent mergers of the three largest casas comerciales with banks reduced the size of the segment - non-bank lenders still have a significant number of clients and thus play an important socio-economic role. The non-bank lenders are also an important source of market dynamics and competition, especially in the lower-end retail segment and for borrowers that have challenges accessing bank financing. However, in some cases, differences in corporate structures and the respective regulatory and supervisory frameworks within the non-bank lender segment imply unequal access to credit information, funding or reporting requirements. Financial conglomerates and interlinkages between financial service providers and firms in the real economy warrant attention from a competition perspective. While Chile has no formal 1 This Technical Note has been prepared by Oliver Masetti (WBG). The note was updated based on internal peer review and comments received from the authorities in February 2022. 2 Lending rates started to increase in Q4 2021 amid a tightening of monetary policy. 4 CHILE definition of financial conglomerates, the CMF identifies 22 business groups that are active in at least two of the areas of banking, insurance, or pension fund management. These groups include all major banks in Chile and have total assets of around 160 percent of GDP. Competition risks stemming from the conglomerate structure are mitigated by several general regulations, such as the general prohibition of tied sales, the legal requirement for banks to tender mortgage related insurance products, rather than to go with their related insurance company, or a recent law regulating the cross- selling of certain loan and insurance products. Nevertheless, the conglomerate structure as well as interlinkages between financial and real sector entities, enabling for example the exclusive use of the real sector entity’s physical infrastructure and customer data, pose inherent competition challenges and authorities need to remain vigilant to detect unilateral conduct or anti-competitive practices. While Chile’s FinTech sector is expanding rapidly, the lack of a regulatory framework creates impediments for new entrants and causes conflicts with incumbent financial institutions. Thanks to its sound internet connectivity and a digitally savvy workforce Chile is home to a bustling FinTech sector focused on payment services, enterprise financial management, wealth management as well as crowdfunding. However, the legal and regulatory framework has not kept pace with technological developments and FinTechs and BigTechs operate largely outside the regulatory perimeter. The lack of comprehensive rules and standards creates uncertainties that complicate the growth of new business models. It also causes tensions between FinTechs, BigTechs and incumbent financial institutions, with each side accusing the other of anti-competitive practices, for example, regarding the allowable use of data scrapping technologies or the closure of bank current accounts for some types of FinTech providers. Absent clear guidance from the authorities, the banking and FinTech associations have started negotiations on some minimum standards and cooperation mechanisms but opposing interests and unequally distributed resources are likely to present main challenges for effective self-regulation. Authorities introduced a FinTech Bill to the Congress in the second half of 2021, which intends to provide regulatory standards for crowdfunding and some other activities. The referred bill also contains a framework for Open Finance, which could help to address some of the challenges in terms of credit information in Chile and improve the ability of FinTechs to compete. However, it is estimated that it will take some time before these activities are fully implemented and it is important that interim solutions, e.g., voluntary guidelines issued by the supervisor, are considered to ensure sound competition and development of the FinTech sector until a comprehensive legal framework is in place. Competition advocacy and enforcement in the financial sector could be further strengthened by deepened inter-agency cooperation. Chilean antitrust and competition laws grant the competition authority (Fiscalía Nacional Económica, FNE) substantial mandates and powers that extend to the investigation and prosecution of anti-competitive practices in the financial sector, with a specialized competition court (Tribunal de Defensa de la Libre Competencia, TDLC). FNE has used its powers pro-actively and carried out 18 investigative processes in the financial sector over the past decade, several of which triggered concrete legal and regulatory changes. The number of such enforcement and advocacy initiatives in Chile is higher than in most LAC peer countries. In contrast to the dedicated competition authorities, CMF does not have a direct competition mandate, but the Banking Act tasks it explicitly with the authorization for mergers and other concentration operations 5 CHILE in the financial sector from a financial stability perspective. Furthermore, CMF’s overall mandate includes the promotion of financial sector development and market conduct, areas that have touch points with competition. A close coordination between the FNE and CMF is crucial to ensure adequate enforcement of competition policies in the financial sector. While a process is established for merger reviews, no formal or informal process is established by which CMF would refer a suspicion of potentially anti-competitive practices involving agencies under its supervision to the FNE for further investigation. Such a process could be beneficial given the respective technical expertise and capacities of the two agencies. Further, without prejudice to its core mandate as a prudential regulator, the CMF could adopt a policy to screen new regulation for its potential impact on competition. Shortcomings in the credit information infrastructure unlevel the playing field for credit intermediation. Equal access to credit information is of crucial importance to enable competition in lending markets. In Chile, however, access to credit information is fragmented, shallow and unequal. While negative credit information is generally available to all interested parties, access to positive credit information is patchy and exclusive. Banks and only certain types of non-bank lenders, as specified in the Banking Act, submit individual debt data to CMF’s consolidated debt database and only those entities are legally allowed to receive this information. In opening access to the CMF database (and extending reporting requirements) to independent casas comerciales CMF recently improved the coverage of credit information and addressed a major competitive distortion that unleveled the playing field within types of the non-bank lending segment. Nevertheless, several types of non-bank lenders, such as cajas de compensacion or factoring and leasing companies, still do not report debt data and are not permitted to access them. This means not only that the CMF database is incomplete as it misses information from those non-bank lenders, but also that access to credit information is unequal. This unequal access to credit information unlevels the playing field against those non-bank lenders than cannot access the database, putting them at a disadvantage when making credit decisions. Like most non-bank lenders, FinTechs and BigTechs do not have access to positive credit information and this has been a main reason why P2P lending models have not yet been implemented in Chile. It is thus crucial that ongoing initiatives to improve access to credit information for all lending institutions, such as work on a new consolidated credit registry, are advanced, considering adequate data quality and safety measures. At the same time attempts to further reduce the available information, for example by deleting historic data on low value defaults, should not pursued further. While authorities recently introduced significant pro-competitive reforms in the card payments market, challenges in the transition to the new scheme delay the envisioned impact. The card payment market in Chile has been subject to several major investigations by the competition authority and proceedings by the competition court over the past years. At the center of these cases has been the role of Transbank, a private entity owned by the main banks in Chile that had been the only acquirer in the country, and its impact on prices and access to payment systems for financial institutions, including PSPs and merchants. The competition procedures triggered a significant change in the card payment market structure from a three-party to a four-party scheme, which is the standard in most peer countries. The new scheme is intended to promote competition by enabling new entities to enter as acquirers and compete with Transbank. However, the transition to the new scheme has 6 CHILE been challenging as new acquirers have struggled to achieve profitability. One reason for this is that between March 2020 and September 2021, Transbank’s prices were frozen -pending a TDLC review of the proposed price stricture – at commercially non-viable levels for certain high volume merchants, that caused losses for Transbank and made it challenging for new acquirers to compete for those merchants. Parallel work on determining limits to interchange fees, another important price component for acquirers, is still ongoing. A swift resolution of these challenges as well as close monitoring of the functioning of the new four-party scheme are important to ensure that the pro- competitive benefits of the reform will be reaped. 7 CHILE Recommendations Responsible Recommendations Time* Authorities Design a regulatory and institutional set-up for effective competition enforcement and advocacy in the financial sector 1 Reinforce inter-institutional cooperation between CMF and FNE to detect anti- CMF, FNE NT competitive practices in the financial sector. (¶ 29) 2 Include competition analysis in existing regulatory impact assessment tool (RIA) CMF NT to ex-ante assess the competition impact of new regulation without prejudice to the core prudential assessment. (¶ 46) Ensure equal access to infrastructure to level the playing field among market operators 3 Promote equal access to credit information by requiring all credit institutions that CMF, I meet minimum standards regarding data safety and quality to provide data to Government the CMF’s consolidated debt registry and grant all credit institutions non- discriminatory access to these data. (¶38) 4 Swiftly conclude the transition to the four-party card payment scheme by FNE, Central I providing clarity on permissible price and fee structure and closely monitor Bank, CMF, competitive dynamics under the new scheme. (¶40) Government Develop/reinforce regulatory tools to foster market contestability and promote competition 5 Monitor and assess the market conduct of financial conglomerates and FNE, CMF I interlinkages between financial service providers for practices that can present potential misuse of dominance. (¶ 32) 6 Swiftly advance the update of the legal and regulatory framework for FinTechs as Government, I well as the Open Banking initiative and consider interim solutions until the new CMF frameworks are in place. (¶ 44) 7 Assess the pro-competitive impact of the Financial Portability Law and stand CMF, NT ready to adjust the framework if needed. (¶ 24) Government *I (immediate) = within one year; NT (near term) = 1–3 years; MT =3-5 years 8 CHILE A. Introduction 1. Competition is conducive to important policy objectives in the financial sector, such as innovation, efficiency, and financial inclusion. Competition can reduce the cost of finance, increase the availability of credit, including to SMEs,3 and enhance efforts among banks to attract customers with more competitive offers thus contributing to financial inclusion. However, several market features inherently limit competition intensity in the financial sector. Natural barriers to entry include significant fixed costs, customer inertia and switching costs, as well as network effects. Government interventions can mitigate or exacerbate these market features and regulatory instruments to safeguard stability may have an impact on competition to various degrees. 2. Fostering competition and market contestability in the financial sector needs to be reconciled with the overarching objective of maintaining financial stability. The promotion of competition and the control of market conduct must be put in the broader context of the overarching importance of protecting the stability of the financial sector. The protection of financial stability does not stand in contrast with competition per se, but some interventions to protect stability can limit or enhance competition. Thus, there is a need to carefully balance the merit of competition considerations and stability concerns, assess trade-offs and, to the extent possible, minimize restrictions or distortions to competition while addressing financial stability or broader prudential concerns. This is particularly important in the design of regulations and the review of concentrations. 3. Policies to foster competition in the banking sector are still incipient in many Latin America and the Caribbean (LAC) economies. A recent assessment of seven large LAC economies (Argentina, Brazil, Chile, Colombia, Mexico, Peru and Uruguay) 4 shows that restricted or distorted competition might be an important supply-side driver of the considerably expensive provision of banking services in LAC (see Box 1). Yet, competition enforcement and advocacy targeting financial markets remain relatively limited in the region. Additionally, country-sector level evidence points to high and growing market concentration, and low levels of contestability. Descriptive and empirical evidence suggests that, with some exceptions, higher bank market shares are correlated with less competitive pricing both in retail deposit and lending products. In this context, key recommendations of that analysis included, among others, the development of an ex ante protocol to assess competition impact of prudential regulations, the review of regulatory provisions for entry and operations by financial operators to eliminate unwarranted competitive restrictions, the introduction of specific guidelines for the assessment of mergers and imposition of remedies in the banking sector, and the prioritization of antitrust enforcement and advocacy initiatives in the banking sector with stronger coordination and cooperation mechanisms between competition authorities and banking regulators. 3 For a full discussion, see WBG, 2016. ‘’Competition in the GCC SME Lending Markets: An Initial Assessment’’. Available at: http://documents1.worldbank.org/curated/en/219781478855303337/pdf/110152-WP- GCCKnowledgeNotesSeriesNov-PUBLIC.pdf 4 WBG, 2020a. ‘’Competition in Retail Banking Services in Latin America’’. September, 2020. Pp. xi-xv. Available at: https://openknowledge.worldbank.org/handle/10986/34444 9 CHILE Box 1: WBG Assessment of competition in retail banking services in LAC Access to financial infrastructure: Restrictions on access to payment systems affects competition negatively. Despite a more proactive stance from regulators to promote competition in payment systems, exclusionary and other anticompetitive practices still pose a significant challenge across the region. Participants of payments markets have often created vertical structures that allow them to restrict competition and the further development of the payments market. Costs of participation in payments infrastructure still represent significant barriers to entry, and caps on fees are not widely used due to weak institutional capacities to periodically assess their impacts on markets. Incumbents could also have incentives to favor the usage of a specific payment instrument which could result in anticompetitive practices. On consumer data, authorities need to ensure a level playing field between big techs and banks. The use of alternative data for credit worthiness evaluation can increase access to credit. However, Big Techs gather a large stock of data as a by-product of their main business which is then utilized as input to offer wider services including financial services. Thus, since Big Techs could become dominant through the advantages afforded by data authorities need to understand the potential impact on competitive conditions of financial services. Elimination of restrictive regulation: The enabling statute of most LAC banking regulators recognize competition as a regulatory principle. In practice, few comprehensive efforts have been made to assess the impact of regulatory interventions on competition and regulators lack mechanisms to assess such impact ex ante or ex post. The introduction of regulatory impact assessment would be key to enable the review of current interventions affecting entry and conduct. This assessment would be key to identify competitive impacts and alternatives that could preserve the prudential policy objective while minimizing competition restrictions. Further collaboration with competition authorities could be beneficial for the implementation of this assessments. Competition law enforcement and advocacy initiatives: LAC authorities are well equipped to investigate anticompetitive practices, execute market studies and engage with other authorities to push for a more competitive banking sector. However, efforts should be increased to apply instruments that have been successful in other sectors (e.g. leniency programs) to the banking sector and to have a more proactive approach to advocacy following the lead of Mexico. Some competition authorities in LAC are not involved in the clearance of some mergers in the banking sector. Powers to impose remedies that minimize the impact on competition must be expanded when needed, including joint design or monitoring with the banking regulator. Additionally, some countries still lack formal predetermined procedures for clearing the merger by multiple agencies which negatively affects predictability. Finally strengthening independence and institutional capabilities of competition authorities would strengthen antitrust enforcement in the banking sector. Source: WBG, 2020a. ‘’Competition in Retail Banking Services in Latin America’’. September, 2020. Pp. xi-xv. Available at: https://openknowledge.worldbank.org/handle/10986/34444 4. The nature of competition in the financial sector is rapidly evolving through entry of operators with business models that leverage new technologies. The digital economy has impacted the provisions of financial products and services widening the perimeter of the financial system and affecting its competitive dynamics. New entrants (FinTechs and BigTechs) apply competitive pressure on conventional incumbent firms by leveraging technology and digital solutions to enable innovative business models. At the same time, a renewed regulatory framework has to 10 CHILE account for these changes and balance potential risks/opportunities. BigTechs and FinTechs often use unbundling and rebundling mechanisms, which causes services to no longer fall within the traditional perimeter of financial services (banking, financial and insurance) but via markets which are not subject to financial supervisory rules.5 The business models of traditional banks are being challenged. Trends show that banks either implement in-house strategies based on digital channel creation, or participate in new FinTech, native digital banks or broader digital platforms within their economic groups.6 Most importantly, incumbents facing new competition could have incentives to suffocate it through anticompetitive practices. Vice versa, BigTechs could leverage their dominance in other markets and adjacent revenue streams or data to adopt aggressive pricing strategies and anticompetitive practices to gain market shares in the financial sector. 5. This note assesses competitive dynamics and potential impediments in Chile’s financial sector in order to provide actionable policy recommendations. This note contains both a quantitative as well as qualitative assessment of competition. The quantitative assessment explores market characteristics and dynamics, including market structure and concentration, cross-ownership and vertical integration, and customer conditions/consumer power. The quantitative assessment is complemented by a qualitative analysis of the regulatory and institutional framework to understand how private and public interventions shape market dynamics and result in specific market outcomes, including efficiency, degree of market power and consumer mobility (Figure 1). The note will focus primarily on the retail banking sector as well as payment systems and discuss competitive dynamics in other parts of the financial sector only to the extent that they affect these two areas, for example in the context of financial conglomerates. 5 Tanda, A. and Schena, C.M., 2019. ‘’FinTech, BigTech and Banks’’. 2019, p. 47. Available at: https://doi.org/10.1007/978-3-030-22426-4_1 6 Ibid., p. 52. 11 CHILE Figure 1: Assessing competition in the financial sector Source: adapted from Calice, P. ‘’Guidance Note on Assessing Competition in the Financial Sector Assessment Program’’ building on the WBG MCPAT. 12 CHILE B. Market Characteristics, Dynamics, and Outcomes 6. Banks dominate financial intermediation in Chile. Total assets of financial intermediaries in Chile stood at 165 percent of GDP in 2020. By far the largest sub-segment is the banking sector, which accounts for 98 percent of financial intermediaries’ assets. Banking sector assets are focused on the loan portfolio, which accounts for 60 percent of banks’ assets in Chile. The loan portfolio is split between commercial loans (58 percent of total credit), mortgage loans (30 percent of total credit) and consumer credit (12 percent of total credit). Bank credit expanded rapidly over the past decade – increasing from 66 percent of GDP in 2010 to 90 percent in 2020 – but credit growth has decelerated sharply since 2020 as uncertainties surrounding the Covid-19 pandemic and high liquidity following exceptional pension fund withdrawals led to a contraction in consumer credit. Nevertheless, Chile’s credit-to-GDP remains the highest in LAC, exceeding peer countries such as Brazil (70.2 percent), Colombia (50.6 percent), Mexico (20.8 percent) or Argentina (12.5 percent) by a wide margin.7 Table 1: Structure of financial intermediaries Dec 2020 Dec 2015 Total assets Total assets (% Share in total Total assets Total assets Share in total Number Number (CLP bn) of GDP) assets (CLP bn) (% of GDP) assets Banks 18 323,127 161.4% 98.0% 24 203,608 127.6% 97.7% Banco de Crédito e Inversiones 57,156 28.5% 17.3% 28,773 18.0% 13.8% Banco Santander-Chile 55,776 27.9% 16.9% 34,654 21.7% 16.6% Banco del Estado de Chile (SOB) 53,119 26.5% 16.1% 32,550 20.4% 15.6% Banco de Chile 46,095 23.0% 14.0% 31,293 19.6% 15.0% Scotiabank Chile 36,796 18.4% 11.2% 8,382 5.3% 4.0% Itaú Corpbanca* 35,687 17.8% 10.8% 14,954 9.4% 7.2% Non-bank lenders 22 6,643 3.3% 2.0% 21 4,688 2.9% 2.3% Cooperativas de ahorro y crédito 7 2,543 1.3% 0.8% 7 1,617 1.0% 0.8% Cajas de compensación y asignación familiar** 4 2,235 1.1% 0.7% 4 1,773 1.1% 0.9% Entidades que otorgan factoring y leasing 3 1,657 0.8% 0.5% 2 694 0.4% 0.3% Casas comerciales*** 7 91 0.0% 0.0% 8 604 0.4% 0.3% Otros oferentes de crédito no bancario 1 117 0.1% 0.0% Total credit sector 329,770 165% 208,296 131% Note: * 2015 figures refer to Corpbanca only, ** credit only, *** credit cards only Source: CMF 7. While the non-bank lending segment is relatively small in terms of assets, it comprises a diverse set of institutions that serve a large number of retail customers. The largest group of non-bank lenders in terms of assets are credit and savings unions (cooperativas de ahorro y crédito). There are more than 40 credit unions in Chile but only the 7 largest are regulated and supervised by the financial sector supervisor (Comisión para el Mercado Financiero, CMF).8 The credit union sector is highly concentrated as the largest credit union (COOPEUCH), which is larger than 7 of the 18 banks, has a market share of 85 percent in terms of assets. The second largest sub-segment are cajas de compensación y asignación familia (CCAFs). CCAFs are private, non-profit entities created by law9 that administer social security benefits but also grant so-called ‘social credit’. Social credits are comparable to consumer credit but the credit amount is usually capped as a low multiple of the borrowers’ income and thus relatively small. Social credits are extended to more than 1 million borrowers, mostly from 7 Data as of Q4 2020. Source: BIS. 8 Smaller credit unions as well as the corporate aspects of all credit unions are regulated by the Ministry of Economy 9 Supreme Decree of the Ministry of Labor and Social Welfare (Law No. 18,833 Article 6) 13 CHILE lower income segments with limited access to the banking system. CCAFs are not deposit taking and are funded through capital markets and bank borrowing. They are supervised by the Superintendency of Social Security. The CCAF market is concentrated and the largest entity, Caja Los Andes, accounts for two-thirds of all credit extended by CCAFs. Individually, Caja Los Andes is the sixth largest provider of consumer credit in Chile. The third largest non-bank lending group, factoring and leasing companies (entidades que otorgan factoring y leasing, FyL), focuses on a narrow market and is specialized in providing automobile loans as well as financing for car dealers. The final group of non- bank lenders in Chile are casas comerciales (CC), also known as ‘retailers’. CCs are credit card providers linked to large retail stores. During the first half of the last decade CCs accounted for almost three- quarters of all credit cards issued in Chile. Although the segment lost importance in recent years, as the three largest CCs merged with banks and the share of credit cards issued by CCs fell to less than one quarter in late 2020, CCs still serve more than 2 million retail borrowers. Banking sector concentration increased in recent years amid several mergers coupled with low volatility of market shares 8. The banking sector is dominated by six banks, whose increasing market share has led to higher concentration. The banking sector consists of 18 institutions. The largest banks in terms of assets are, in order of importance, Banco de Crédito e Inversiones, Banco Santander-Chile, Banco del Estado de Chile (Banco Estado), Banco de Chile, Scotiabank Chile, and Itaú Corpbanca. These six banks account individually for 11 to 18 percent of total assets and their combined market share stood at 88 percent of total banking sector assets in late 2020. CMF has designated these six banks as domestic systemic financial institutions (D-SIBs) that after a transition period will be required to hold additional capital buffers. The other 12 banks operating in Chile are small and none of them accounts for more than 3 percent of total banking sector assets. Despite the dominant market share of the top-6 banks, the asset Herfindahl-Hirschman Index (HHI) stands at only 1360, a level indicating moderate concentration, and is lower than in most LAC and international peer countries.10 This can be explained by the relatively comparable market shares of the top-6 banks and the lack of a single dominant bank. As the market share of the top-6 banks increased by 9 ppt over the past five years, quantitative concentration measures are on an upward trend, with the asset HHI increasing by 160 points since 2015. The increase in concentration has been observable across all major lending products but was more pronounced for mortgages and commercial loans than for consumer loans. Most deposit products, which are generally more concentrated than lending products, also have seen a significant increase in concentration over the past years (see Figure 2). 10 The U.S. Department of Justice defined markets in which the HHI is between 1,500 and 2,500 points as moderately concentrated, and markets in which the HHI is in excess of 2,500 points as highly concentrated. See the United States Department of Justice website, Antitrust Division, Herfindahl-Hirschman Index, 2018. 14 CHILE Figure 2: Concentration in the banking sector Asset concentration Asset HHI (international comparison) 100% 1400 3500 90% 1350 3000 1300 2500 80% 1250 2000 70% 1200 1500 60% 1000 1150 50% 1100 500 0 40% 1050 Brazil Colombia Peru Morocco South Africa Chile Thailand Mexico 2017 2020 2011 2012 2013 2014 2015 2016 2018 2019 Top-3 market share Top-6 market share HHI, rhs LAC peers International peers Concentration by lending product Concentration by deposit product HHI, individual institution HHI, individual institutions 1700 1600 2000 1500 1800 1400 1600 1300 1400 1200 1200 1100 1000 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 1000 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Commercial credit Consumer credit Current accounts (individuals) Current accounts (firms) Mortgages Term deposits Source: CMF and FitchConnect 9. The increase in concentration came on the back of several market exits and mergers and that reduced the number of banks and solidified the market share of the top-6 banks. Since 2015, the number of banks operating in Chile decreased from 24 to 18, as six market exits and two mergers outnumbered the three market entries (see Figure 3). The market exits were predominantly due to foreign banks ceasing operations in the country, while market entries were relatively scarce. None of the new entrants, two Chinese and one Brazilian bank, managed to gain significant market share and each accounted for less than 0.7 percent of banking sector assets in 2020. The largest impact on market structure and concentration came from the two mergers. In 2016, the then fifth largest bank Corpbanca merged with the eight largest, Banco Itau Chile. In 2018, sixth largest bank, BBVA, and seventh largest bank, Scotiabank Azul, merged. The mergers significantly increased the top-6 banks’ market share and drove the increase in concentration across product categories. 15 CHILE Figure 3: Entry, exit and mergers of financial intermediaries Source: SFC 10. Outside mergers, only few banks managed to significantly increase their market share through organic growth. Except for the two mergers, which significantly increased the market share of the merged institutions, few banks saw their market share in specific product segments increase by more than 1 percentage point over the past five years (see Figure 4). Variability of market shares appears more pronounced in the consumer credit and mortgage market where at least two banks saw their market share grow organically, i.e. not due to a merger, by more than 1 percentage point. On the deposit side, market share dynamics have been highest for individuals’ current accounts, where two banks organically grew their market share by more than 1 percentage point and two banks lost more than 1 percentage point. 16 CHILE Figure 4: Market share dynamics 2015-2020 Note: Red bars indicate changes in market share of banks merged between 2015 and 2020 Source: Own calculation based on CMF data While the role of non-bank lenders declined, recent years have seen a sharp increase in the number of FinTechs that can compete with conventional players in selected market segments 11. Significant changes occurred in the non-bank lending segment that reduced the market share of those institutions, particularly in the credit card segment. Non-bank lenders, particularly casas comerciales (CCs), credit card providers linked to large retail stores, had in the past played an important role in providing credit cards and consumer credit primarily to lower income borrowers. In early 2014, almost three quarters of all credit cards in Chile were issued by CCs. However, since then the segment lost significantly on market share as the largest three entities were merged or acquired by banks.11 As of mid-2021, cards issued by CCs accounted for only 20 percent, with the vast majority 11 In December 2013, Banco Ripley acquired a majority stake in the of CAR S.A. In May 2015 Scotiabank acquired 51 percent of CAT Administradora de Tarjetas S.A., associated with Cencosud. In December 2018, Promotora CMR and Presto S.A became SAGs of Banco Falabella and Banco BCI, respectively. 17 CHILE issued by banks or bank linked Sociedades de Apoyo al Giro (SAGs). 12 In parallel to the declining number of cards issued by CCs, their credit volume dropped to by almost 80 percent since 2014, confirming the declining importance of CCs as a source of consumer credit. On the other hand, the acquisition of three CCs increased banks’ exposure to the high-yield unsecured consumer lending market and further strengthened the market position. Figure 5: Credit card market Number of credit cards (mn) Credit card credit (US$ bn) 18.0 4.0 16.0 3.5 14.0 12.0 3.0 10.0 2.5 8.0 6.0 2.0 4.0 1.5 2.0 1.0 0.0 Jul-13 Nov-15 Mar-18 Oct-18 May-19 Jul-20 Dec-12 Feb-14 Sep-14 Apr-15 Jun-16 Jan-17 Aug-17 Dec-19 Feb-21 0.5 0.0 2012 2013 2014 2015 2016 2017 2018 2019 Casas comerciales Banks* Casas Commerciales * Includes Instituciones bancarias, Cooperativas y Sociedades de Apoyo al Giro bancario Source: CMF, Banco Central de Chile 12. Recent years have seen a sharp increase in the number FinTechs but the lack of a regulatory framework inhibits the growth of the segment and causes conflicts with incumbents. The number of FinTechs operating in Chile has quadrupled over the past four years to around 200 in mid-2021, making Chile one of the largest FinTech markets in the LAC region. In recent years also BigTech companies, such as MercadoPago, entered the Chilean market. The majority of Chile’s FinTechs and BigTechs are active in the areas of payments and remittances, enterprise financial management as well as crowd funding. While the growth of FinTech is supported by Chile’s sound internet connectivity and a digitally savvy workforce, the legal and regulatory framework has not kept pace with technological developments, and most FinTechs and BigTechs operate outside the regulatory perimeter. Currently, there is no dedicated regulatory framework in place for FinTechs and FinTechs are neither required to obtain a license nor are they supervised by the CMF. This lack of comprehensive rules and standards combined with uncertainties about potential future requirements complicates the growth of new business models. It also causes tensions between FinTechs, BigTechs and incumbent financial institutions, with each side accusing the other of anti-competitive practices, for example, regarding the allowable use of data scrapping technologies or the closure of bank 12 SAGs or ‘business support companies’ are entities owned and established by banks with the purpose of i) providing services on behalf of banks, or ii) carrying out certain banking operations with the public. SAGs, for example, provide electronic funds and data transfer services, credit card management, ATM operations or payment collection on behalf of banks. 18 CHILE accounts for crypto and FX platforms or payment initiators. Absent clear guidance from the authorities, the banking and FinTech associations have started negotiations on some minimum standards and cooperation mechanisms but opposing interests and unequally distributed resources are likely to present main challenges for effective self-regulation. Authorities have started to fill this void and designed and introduced a Fintech and Open Finance bill (see paragraph 42), which intends to provide minimum standards for crowdfunding and several other activities. While the bill is already discussed in congress (second constitutional stage), it is estimated that these initiatives will take some time before being fully implemented. Financial conglomerates and interlinkages between financial service providers and firms in the real economy warrant attention from a competition perspective 13. Market dynamics are also shaped by the existence of financial conglomerates throughout the financial system. While Chile has no formal definition of financial conglomerates, the CMF identifies 22 business groups that are active in at least two of the areas of banking, insurance, or pension fund management. Thirteen of these conglomerates include banks, 13 include at least one non-bank lender, 14 have an insurance company, four a pension fund operator, and 16 an investment fund or asset management entity. All major banks in Chile are part of a financial conglomerate and total assets of the conglomerates stand at around USD 460bn or 160 percent of GDP. Of those assets 83 percent are bank assets, indicating the importance of banks within financial conglomerates. Figure 6: Financial conglomerates Structure and activities of financial conglomerates Investment Non-bank Pension Fund Banks Insurance funds and asset lender operators management Yarur Luksic Santander Scotiabank Itaú Consorcio Matte Security CCHC MetLife Falabella Penta Sura BTG Pactual Ripley Tanner Euroamérica 19 CHILE Larraín Vial Renta Nacional JP Morgan Avla Principal Source: Own illustration based on CMF data 14. While several regulations are in place to mitigate risks of tying and forced-cross selling, linkages between financial and real sector entities may warrant attention from a competition perspective. Contrary to Latin American peers, such as Colombia, Chile does not have a dedicated financial conglomerates law to establish consolidated supervision and regulate prudential, governance and conduct aspects of financial conglomerates.13 However, competition risks stemming from the conglomerate structure are mitigated by several general regulations, such as the prohibition of tied sales in the Consumer Protection Law, as well as a law requiring banks to call for public tenders to grant life insurance for all their mortgage clients rather than to go with their related insurance company.14 A further important safeguard is the 2021 amendment to the Commercial Code, which clarifies and limits the type of insurance products that banks can request from clients before granting the loan and thus sets limits for cross-sales. However, a recent lawsuit accusing a bank to have abused its dominant position in a tender to grant mortgage linked life insurance to a related insurer highlights that continuous vigilance and eventual legal updates are necessary to prevent anti-competitive practices within financial conglomerates (see paragraph 32). 15 Financial service providers are also often linked to entities in the real sector (i.e., retail stores or supermarkets). This allows the financial institutions within the same group to use the physical infrastructure network of the real sector entity (i.e., retail stores) to on-board clients and distribute products. It also allows them to exclusively access data, subject to the restrictions in the Data Protection Act, for tailoring and pricing of products. Another example of potential competition challenges arising from the linkages between financial and real sector entities that warrant further analysis is the reluctance of a dominant retail chain, which is linked to a credit card issuing financial institution, to accept prepaid cards. The State has a significant footprint in the financial sector through its ownership of the third-largest bank in Chile as well as a large public guarantee fund. 15. Chile’s only state-owned bank, Banco Estado, has both a developmental and commercial mandate. Banco Estado is a fully owned state-owned financial institution established by law in 1977 (Decreto 2,079 of 1977). With assets of roughly CLP 54bn, it has a market share of 16 percent and is the third largest bank in Chile. Its market share has been fairly constant over the past years. Decreto 2,079 tasks Banco Estado with providing banking and financial services in order to favor the development of national economic activities, as well as with supporting the regionalization of the 13 Authorities are currently in the process of designing a financial conglomerates law, 14 The client has the possibility to pick another company to provide these services to him individually, but this right is almost never exercised due to switching costs and usually higher prices. 15 The Law was updated and amended in 2021. 20 CHILE country by providing access to finance in remote areas. In fact, Banco Estado, is the only bank with branches (including through cajas vecinas) in all of Chile’s communes, in many of which it is the only bank present, and it accounts for more than 40 percent of total banking sector credit in eleven, mostly rural, of Chile’s sixteen provinces. Banco Estado offers a free basic transaction account (Cuenta RUT), linked to the national ID (Rol Único Tributario, RUT), which is used by almost 80 percent of the population. In addition, to its developmental activities, the bank also engages in commercial activities, such as lending to large corporates or mortgages, where it competes with private banks. Banco Estado has some advantages on the funding side as its large branch network and Cuenta RUT allow it to attract sizeable deposit funding. The bank also received several public capital injections, most recently in October 2021 in order to comply with Basel III requirements.16 Banco Estado is supervised by CMF and subject to the same prudential regulations as private banks. It is one of the six domestic systemic financial institutions (D-SIFIs) designated by CMF and, as the five private D-SIFIs, it will have to keep additional capital buffers once the transition phase commences. 16. The Government also indirectly supports credit intermediation through the public credit guarantee fund FOGAPE, which gained further importance during the COVID-19 pandemic. The Fondo de Garantía para Micro y Pequeños Empresarios (FOGAPE) is a legal entity created by law (Decree Law No. 3,472 of 1980) with the purpose of promoting access to finance for those companies that lack collateral or guarantees to access the formal financial system. As specified by the law, the administration of FOGAPE is housed within Banco Estado but separated from the bank’s operations and business management. FOGAPE guarantees are intended for small and medium-sized enterprises although in response to the COVID-19 pandemic the annual sales threshold was increased so that larger firms could become eligible too. As part of the COVID-19 response, FOGAPE increased its coverage limit up to 85 percent for small companies and 80 percent for medium-sized companies from 50 percent and 30 percent, respectively. These changes, together with the economic hardship and uncertainty caused by the pandemic, resulted in a surge in demand for FOGAPE guarantees. Access to FOGAPE guarantees is generally non-discriminatory and open to clients of all financial institutions in Chile. While prior to the COVID-19 pandemic FOGAPE performed a bidding process and worked with those institutions that requested the lowest coverage17, this system was replaced by a uniform allocation per bank during the pandemic. Uptake and demand, however, vary significantly across financial institutions. The largest user of the guarantees extended under the FOGAPE-Reactiva program18 launched in response to the COVID-19 pandemic, has been Banco Estado with roughly 25 percent of the guarantee amounts approved. As part of the COVID-19 response, bank lending to eligible MSMEs with a FOGAPE guarantee could access cheap funding from the Central Bank under the Conditional Financing Facility for Increased Loans (FCIC). This source of funding, however, is only 16 Law No. 21,384 came in force on October 21, 2021. 17 For example, for the period April to June 2020 18 financial institutions were awarded guarantee or re-guarantee rights. 18 FOGAPE-Reactiva loans are intended for investment, refinancing of certain current loans, and working capital. In addition, the nominal rate is defined as the MPR plus 0.6% per month, equivalent to 7.7 percent per year based on the current MPR, which may allow access for riskier or smaller businesses. The FOGAPE-Reactiva program also provides greater state guarantees for sectors that have been hard hit by the crisis and for loans that finance investment in fixed assets. The FOGAPE-Reactiva program extended 222,000 guarantees in 2021. 21 CHILE accessible to banks - as per the Central Bank Act only banks are eligible to receive Central Bank funding –and non-bank lenders, such as credit unions, had no access. Profitability and efficiency indicators do not suggest that banks are able to extract unusually high profits and do not see large banks benefitting from their prominent market positions 17. The profitability of Chilean banks is relatively low and large banks are not significantly more profitable than their smaller competitors. The system-wide return on assets (RoA) and return on equity (RoE) were at relatively low levels of 1.34 percent and 16.6 percent, respectively in 2019 and dropped to 0.5 percent and 7.7 percent in the wake of the COVID-19 pandemic in 2020.19 Both, the pre-COVID as well as the 2020 profitability ratios are at the lower range of peer countries and do not suggest that banks have been able to generate excess profits. Further, within Chile there is no statistically significant relationship between a bank’s market share and its profitability. In fact, several smaller banks that focus on niche market segments manage to achieve higher profitability than the top-6 universal banks (see Figure 7). This also weakens the hypothesis that large banks are able to use their market position to generate large profits. Figure 7: Profitability International comparison (RoA)* RoA and market share 5.0% 2.5 2.0 4.0% Average RoA 2017-2019 1.5 3.0% 1.0 2.0% 0.5 0.0 1.0% Brazil Mexico South Africa Romania Peru Chile Colombia** Thailand 0.0% y = -0.0094x + 0.0142 R² = 0.0031 -1.0% LAC peers International peers 0.0% 5.0% 10.0% 15.0% 20.0% 2018-2019 2020 Average market share 2017-2019 Source: CMF, IMF FSI Note: * Pre-tax RoA; ** Profitability data for Colombia are taken from SFC and differ from the FSI data as the FSI data also include the second-tier financial institutions in the aggregate profitability figure. 18. Moderate profitability of Chilean banks cannot be explained by higher costs, as most efficiency indicators outperform peer country banks. Different indicators of cost efficiency (non- interest expenses to assets, personnel expenses to assets) of Chilean banks outperform those of most 19 Pre-tax RoE and RoA. 22 CHILE peer country banks (see Figure 8). This refutes the hypothesis that the lower profitability of Chilean banks is driven by lower efficiency or higher operating costs and suggest that the moderate profitability comes from weak income rather than high costs. A comparison within Chile shows that the large banks tend to have lower cost ratios and thus higher cost efficiency than smaller banks. This is likely linked to economies of scale as well as more efficient use of internal processes of the larger banks that allow them to more easily recoup fixed costs and benefit from synergies. However, this higher cost efficiency of large banks does not translate into higher profitability as discussed above. Figure 8: Cost efficiency Cost efficiency ahead of peer countries Larger banks tend to be more cost efficient 2020 2020 4.0% 10.0% Non interest expenses to assets 3.5% 9.0% 3.0% 8.0% 2.5% 7.0% 6.0% 2.0% 5.0% 1.5% 4.0% y = -0.08x + 0.0317 1.0% 3.0% R² = 0.0662 0.5% 2.0% 0.0% 1.0% Non-interest expense-to- Personel expense-to- 0.0% assets assets 0.0% 5.0% 10.0% 15.0% 20.0% Chile Brazil Mexico Peru Romania Thailand Market share Source: Own calculation based on CMF, IMF FSI data 19. Net interest margins in Chile are relatively low and have declined further in recent years. Net interest margins (net interest income divided by total assets) are commonly viewed as an important indicator of the efficiency of credit intermediation. A high wedge between lending and deposit margins is associated with credit rationing and thus a lower level of credit channeled to borrowers (Stiglitz and Weiss, 1981). The net interest margin in Chile, at 2.7 percent in 2020, is lower than those of LAC peer countries, while comparable with international peers (see Figure 9). Interest margins in Chile are on a downward trend having decreased from 3.4 percent in 2014. To some extent, the decline in interest margins can be explained by compositional effects as the share of high yield consumer credit in total credit dropped from 14 percent in 2014 to 12 percent in late 2020, while over the same time the share of low-yield mortgages increased by 5 percentage points. However, as discussed below in more detail, the decline in interest margins, came also on the back of significant and wide-spread reduction in lending rates that reduced the cost of financing. Comparing interest margins within Chile shows no significant differences between the larger and smaller banks. Notably, the variation of interest margins among the top-6 banks is very small, ranging from 2.1 percent to 2.8 percent. Among the large banks, the interest margin is lowest for Banco Estado. 23 CHILE Figure 9: Interest margin Net interest margin declined over time,… … and is below LAC peers Net interest margin (% of total assets) Net interest margin (% of total assets, 2020) 7.0% 4.0% 3.5% 6.0% 3.0% 5.0% 2.5% 4.0% 2.0% 3.0% 1.5% 2.0% 1.0% 1.0% 0.5% 0.0% 0.0% Chile Brazil Mexico Peru Romania Thailand 2014 2015 2016 2017 2018 2019 2020 LAC peers International peers Interest margin and market share Interest margin decomposition 2020 Components of net interest margin (% of total) 16.0% 100% Net interest margin (% of assets) 14.0% 80% 12.0% 10.0% 60% 8.0% 40% y = -0.0612x + 0.0349 6.0% 20% R² = 0.0162 4.0% 0% 2.0% 2018 2019 2020 0.0% Loan-loss provisions 0.0% 5.0% 10.0% 15.0% 20.0% Overhead costs - Non-interest income Market share Taxes Profits Source: Own calculation based on CMF, IMF FSI data 20. Decomposition of net interest margins shows a moderate contribution of profits which does not raise competition concerns. The economic literature identifies a high contribution of profits to net interest margins as a sign of limited competition in the financial sector.20 In the case of Chile, however, a decomposition of net interest margins using a simple accounting identity (see Appendix A1) reveals that profits accounted for around one-third of net interest margins prior to the pandemic, with their contribution falling to 15 percent in 2020 as profits dropped in the wake of the pandemic. The contribution of profits is comparable to peer countries, such as Colombia, and does not reach a level indicating limited competition. The largest contributions to the net interest margin are overhead costs (net of non-interest income) as well as loan-loss provisions. The contribution of 20In the economic analysis of spreads, Demirgüç-Kunt and Huizinga (1999) regress spreads and profits on measures of concentration (as an indicator of competition) and conclude that, aside from other factors, lack of bank competition drives bank spreads and profits across countries. Similarly, Beck and Fuchs (2004) conclude that the high profit margins that explain part of the high spreads in Kenya are due to lack of competition in the banking sector. 24 CHILE loan-loss provisions has increased in 2019 and 2020 as banks built higher provisions amid the impact of the social protests and the COVID-19 pandemic. 21. The fall in interest margins was not compensated by an increase in banks’ fee and commission income. The system-wide ratio of net commission and fee income to total assets remained broadly stable between 2015 and 2019 at around 0.7 percent before dropping to 0.4 percent in July 2021 amid the COVID-19 pandemic. Similarly, the contribution of commission and fee income to banks’ total income remained constant at a system average of around 17 percent. Focusing only on the part of commissions and fees that are directly linked to banks’ credit offering21 shows a similar picture and the share of credit-related commission income to total credit even declined slightly from 0.54 percent in late 2015 to 0.37 percent in July 2021. Comparing fee and commission income within Chile shows no significant differences between large and small banks. Large banks do not earn statistically significant higher credit-related fees and commissions per unit of credit than smaller banks, suggesting again that large banks seem incapable to use their market position to generate surplus rents. Nevertheless, more granular data on the fee level per product and bank would be useful to strengthen transparency and market discipline and further reduce the risk that non- interest fees and commissions are used to extract consumer surplus. Price pressure, portfolio purchases and high customer mobility indicate a significant degree of competition particularly in the retail credit segment. 22. Lending interest rates have decreased for all major products indicating competitive pressure. Over the past five years - and accelerated by the impact of the COVID-19 pandemic - interest rates have declined for all major lending products in nominal and real terms (see Figure 10). The decline was on average slightly higher for commercial loans (-34 percent) than for mortgages (- 25 percent) and consumer loans (- 24 percent).22 The fall in lending rates was widespread as almost all banks reduced their lending rates during that period. A simple regression model (see Box 2) shows that the fall in lending rates is still observable when the model is adjusted for changes in risks, funding costs, inflation and the monetary policy stance. The reduction in lending rates was also not confined to the banking sector as most non-bank lenders23 reduced their lending rates in tandem with banks. The average level of lending rates is well below the limits established by the interest rate cap (see paragraph 45), and it is unlikely that the recent fall in lending rates has been driven by the caps rather than market forces. While the most recent reduction in lending rates since early 2020 is likely to be affected by the impact of the COVID-19 pandemic and the associated support measures, the longer- term trend, combined with the view of market participants interviewed during the mission, point towards competition in the lending market that puts downward pressure on prices. 21 Ingresos por comisiones y servicios de i) líneas de crédito y sobregiros, ii) avales y cartas de crédito, y iii) servicios de tarjetas. 22 The trend of falling interest rates partially reversed in Q4 2021 as monetary policy tightened. 23 Data are primarily available for credit unions. 25 CHILE Figure 10: Lending rates Lending rates (%) 35.0 30.0 25.0 20.0 15.0 10.0 5.0 0.0 Credit card* Instalment Overdraft Average Instalment Overdraft Average credit consumer credit commercial credit credit Consumer credit Mortgages** Commercial credit CPI 2015 2017 2019 Jul-21 Notes: * Tarjeta crédito rotativo; ** Mortgage interest rates for credits in UF. Source: CMF 26 CHILE Box 2: Analyzing the fall in lending rates To analyze if the observed fall in lending rates over the past years indeed points to competition or if it can be primarily explained by other factors, such as differences in the risk profile of loans, changes in funding costs or inflation, the following simple regression model is estimated: , = 1 + 2 , + 3 + 4 + If the time trend, once controlled for risk, funding cost and inflation, still points to a significant reduction in lending rates over time, other factors contributed. The hypothesis is that competitive dynamics are among those factors. As shown in the table below, the coefficient on the time trend is indeed negative and significant for all three main categories of lending rates. This suggests that the fall in lending rates cannot be fully explained by differences in the other explanatory variables and strengthens the hypothesis that competition played a role. As a robustness check we replace in Column (4) deposit rates with the monetary policy rate to also control for changes in the monetary policy stance. The additional control variable does not change the coefficient for the time trend and thus adds robustness to the findings. (1) (2) (3) (4) Interest rate Interest rate Interest rate Interest rate commercial consumer loans mortgages consumer loans VARIABLES loans Time trend -0.065*** -0.021*** -0.021*** -0.062*** [-9.56] [-3.24] [-6.28] [-10.50] NPLs Consumer Loans 0.358* 0.357* [1.71] [1.73] NPLs Commercial Loans -1.296* [-1.89] NPLs Mortgages -0.115 [-0.80] Deposit rates 0.066 0.312** 0.073 [0.51] [2.47] [1.23] CPI -0.012 -0.179** -0.060* 0.009 [-0.15] [-2.31] [-1.67] [0.11] Monetary Policy Rate 0.134 [1.12] Constant 23.138*** 9.088*** 4.262*** 22.822*** [28.38] [6.52] [9.02] [28.60] Observations 78 78 78 78 R-squared 0.898 0.741 0.818 0.900 t-statistics in brackets, *** p<0.01, ** p<0.05, * p<0.1 23. For deposit products banks focus on differentiation through a better customer experience and digital offerings rather than higher deposit rates. Over the past five years deposit 27 CHILE rates fell for all maturities and were below the annual inflation rate for most tenors. Rather than offering higher deposit rates, banks try to attract and retain clients be enhancing their digital product offerings. The pressure to digitize banking services comes both from the demand side where customers increasingly expect to be able to transact through mobile and digital solutions rather than physical branches as well as from the supply side where FinTech entrants introduce sophisticated solutions that set standards for the industry. Further, the exceptional pension fund withdrawals granted in response to the COVID-19 pandemic, which to a large extent were deposited in domestic banks, have significantly increased the liquidity in the banking sector and combined with sluggish lending growth, reduced the need to grow the deposit base and thus the incentive to compete by increasing rates. 24. Multi-banking relationships point to a certain degree of consumer power and recent legal changes aim to reduce switching costs and further enhance customer mobility. On average a borrower has banking relations with more than three different credit institutions, according to debt stock data as of end 2020. The widespread existence of multibank relationships points to consumer power to choose and switch across different credit providers. However, customer mobility is reduced by fees linked to the early repayment of credits. For example, if a credit is less than UF 5,000 (US$ 188,000), 1.5 months of interest is charged as a pre-payment fee. To improve customer mobility authorities implemented a Financial Portability Law (Law 21,236) in September 2020. The law aims to facilitate moving existing financial products from one financial institution to another by reducing switching costs and standardizing and accelerating procedures. The law also stipulates that more information is provided to clients to enable them to better compare products and identify those with better commercial conditions. This is an important aspect as limited comparability and a lack of understanding of financial products, amid generally low levels of financial education, are significant impediments that can cause inertia and prevent customers from realizing the benefits of portability. The law applies to banks as well as non-bank lenders and insurance companies. It covers most retail banking products but appears most suitable for mortgages. So far, the impact of the new law appears mixed. Between October 2020 and September 2021 more than 300,000 requests to switch financial providers (solicitudes ingresadas) were submitted but only around 12,000 actual moves are recorded. Reportedly many clients use the request for portability as a tool to renegotiate terms with their currently lender but ultimately stay. This might change going forward as the law is still fairly new and was implemented in a relatively short-time period that made it challenging for banks to adjust their systems and processes accordingly. Authorities should thus continue to monitor the impact of the law on consumer mobility and, if necessary, recalibrate the framework to ensure that its intended impact is fully realized. 28 CHILE C. Interventions that shape market dynamics I. Institutional and regulatory framework 25. A strong institutional framework is essential for effective competition policy in the financial sector. Authorities in many jurisdictions are increasingly concerned with the level of competition in the financial sector, especially in retail banking markets and payments systems, and consider market structure, entry and expansion barriers, and switching costs as key factors for competition. The main areas of competition policy, namely cartels, abuse of dominance and mergers, and, in some jurisdictions even state aid, are thus highly relevant for the financial sector. However, the promotion of competition and the control of market conduct in the financial sector must be put in the broader context of the overarching importance of protecting the stability and soundness of the financial sector. In light of the complex relationship between competition and financial regulation policy, appropriate institutional arrangements are important to alleviate tensions between financial stability-oriented regulation and competition policy enforcement. The important specificities in the relationship between competition and financial stability require a departure from canonical competition policy frameworks to one that stresses effective cooperation between authorities.24 Box 3: Legal and institutional frameworks for competition policy in the banking sector Competition policy in the sector is mostly shaped through ex ante or ex post interventions by a sectoral regulator and a competition authority. Sectoral regulators and competition authorities commonly have different mandates and toolkits to promote and protect competition in the banking sector. However, instances of agency interaction are also common, and the boundaries of action of each agency depend on their enabling statutes and the scope of the substantive laws they apply. A competition law at its core is meant to define conduct deemed anticompetitive and enables a competition authority to control firm behavior ex post, and advocate for competition before other authorities that intervene in the banking sector. The competition law is generally cross-sectoral, but exemptions for certain practices or sectors are also common. Banking regulators can also have competition law enforcement powers, notably in merger review, where a clearance from a prudential perspective may be coupled with the need to account for the competitive effects of the transaction. Even in that scenario the competition authority may still be involved in the procedure through opinion giving or others. Sectoral regulatory interventions are often granted exclusively to banking regulators/central banks, with several jurisdictions adding mandatory alignment with pro-competition principles in enabling statutes. Baking regulation may supersede competition law (i.e., preemption of one legal instrument over another) thus ex ante shielding certain conducts or practices from antitrust scrutiny. Figure 11 maps the instances of intersection and interplay described above. 24 World Bank (2021), Guidance Note on Assessing Competition in the Financial Sector Assessment Program. 29 CHILE Figure 11: Key questions on the intersection and interplay between competition and regulatory legal framework and institutional setup in the banking sector Source: WBG, 2020a. ‘’Competition in Retail Banking Services in Latin America’’. September 2020. P. 5. Available at: https://openknowledge.worldbank.org/handle/10986/34444 The institutional framework for competition policy in Chile could be further strengthened by enhanced inter-agency cooperation 26. In Chile, the Fiscalía Nacional Económica and Tribunal de Defensa de la Libre Competencia are the central institutions to enforce and promote competition across sectors, including in financial markets. Chilean Competition Law (Law No. 211 of 1973) seeks to promote and defend competition in the marketplace. The rules established by the Competition Law and its amendments apply without distinction to all economic agents and activities, hence, they fully apply to banks and other financial institutions. The main agencies responsible for enforcing the Competition Law are the Fiscalía Nacional Económica (“Competition Agency” or “FNE”) and the Tribunal de Defensa de la Libre Competencia (“Competition Court” or “TDLC”). The FNE is responsible for the investigation and prosecution of anticompetitive conduct and has advocacy powers to issue regulatory recommendations to the Government as well as guidelines to private entities. It has five main thematic divisions. The Anti-trust Division takes complaints as well as ex-officio inquiries and conducts investigations that can result in the imposition of remedies or in bringing charges to the TDLC. The Market Study Division, founded only in 2017, performs deep-dive studies to detect potential anticompetitive practices, which then result in proposals of regulatory or legal adjustments to the Government or sector regulator. The third division is the Merger Review Division, which ex-ante reviews all mergers above a certain threshold and can also conduct ex-post reviews below the threshold (see paragraph 28 for more details). The Anti-cartels Division focuses on collusive practices, manages the leniency program and develops market screenings to identify possible cartels. Finally, in February 2021, a new Compliance Monitoring Division was launched, in charge of monitoring the execution and compliance of remedies imposed by the TDLC or agreed upon merger reviews, settlements and voluntary commitments of undertakings. The second main agency, TDLC, is an independent court that 30 CHILE decides cases brought by the FNE or private parties, with a mixed composition of judges (five lawyers and three economists). TDLC´s final decisions are only subject to appeals before the Supreme Court. 27. The CMF is first and foremost Chile’s prudential supervisor with no direct competition mandate. Comisión para el Mercado Financiero (CMF) is the prudential regulator and supervisor responsible of overseeing banks, insurance companies, asset managers, securities markets, and brokers, as well as several other financial institutions. It has under supervision more than 70 percent of the financial sector assets in Chile. CMF’s mandate (Article 1 of Law 21,000 of 2017) is to ‘…ensure the proper functioning, development and stability of financial markets.’ CMF in its current form is a relatively new entity as prior to 2017-2019, separate entities were in charge of supervising banking, insurance, and capital markets. While CMF does not have a direct competition mandate, the Banking Act tasks it explicitly with the authorization of mergers and other concentrated operations (see paragraph 28). Furthermore, its overall mandate of promoting financial sector development and proper functioning are topics affected by competitive dynamics. The role of Central Bank of Chile, the other main public agency in the financial sector, to promote competition in the financial sector remains limited except for knowledge generation through several empirical studies in the past as well as its role as regulatory authority for payment systems. 28. When it comes to the review of mergers in the financial sector, the legal framework requires the participation of both the FNE as well as CMF. The review of mergers and acquisitions from a competition perspective aims at limiting harmful market effects of economic concentration and to identify ex-ante situations in which a change in the market structure may increase the likelihood of anticompetitive practices that can adversely affect market outcomes and harm consumers. In Chile, the review of large25 mergers in the financial sector is structured as a two-step process with clearly defined roles for FNE and CMF. Following amendments to the Competition Law in 2016 (Law 20.945), as a first step, FNE needs to ex-ante review the competition impact of a proposed merger.26 Within this process, FNE first screens if the merger causes specific competition concerns and, if the screening does indeed identify such concerns, FNE conducts a subsequent in-depth investigation and can consider remedies and/or blocking of the merger. This assessment is run independently from CMF, although FNE can request data and other information from CMF for its assessment. If FNE approves the merger from a competition standpoint, the review process moves to the second step, which is CMF’s assessment of the merger’s prudential impact. The requirement for CMF to review mergers, as stated in the Banking Act (Decreto con Fuerza de Ley 3, Article 35), applies when the merger or acquisition accounts for more than one-third of the bank's balance sheet, the acquisition implies control over two or more banks by the same person or group, when there is a substantial increase of the existent controlling power, or when the acquiring bank would reach systemic importance.27 CMF’s 25 Thresholds regulate the involvement of FNE as well as CMF in the ex-ante merger review process. 26 This applies to merger where the sales of at least two of involved parties exceed ~US$ 20mn or the joint sales exceed ~US$ 100mn) the first step is an 27 In case CMF denies the authorization of mergers or other concentration operations between banks of systemic importance, it must require the agreement of the Central Bank Board. 31 CHILE review focuses exclusively, as stipulated by the Banking Act, on the potential impact of the merger on financial stability and soundness of the financial system. 29. Competition advocacy and enforcement in the financial sector could be further strengthened by deepened inter-agency cooperation. Outside merger reviews, there is little cooperation between FNE and CMF. In particular, there is no process established by which CMF refers a suspicion of anti-competitive practices to FNE for further analysis.28 Most of the initiatives of FNE’s antitrust and market study divisions are started by complaints of affected parties or based on FNE’s own research. However, while FNE has deep knowledge and expertise regarding competition in general it does not have in-house resources dedicated solely to the financial sector and neither is it tasked or equipped to closely monitor financial sector actors and behaviors. In contrast, as the prudential supervisor, CMF has deep knowledge of the financial sector and its developments. Establishing a process by which CMF refers suspicions of anti-competitive practices that it detects through its supervision and monitoring to the FNE for further investigation might thus best utilize the respective technical expertise and capacities of the two agencies. FNE has a similar process in place with Chile’s energy regulator. II. Competition enforcement: regulatory and institutional aspects Competition enforcement and advocacy is pro-active but continued vigilance is needed to detect anti- competitive practices 30. Chilean antitrust and competition law grants FNE substantial powers to investigate and prosecute anti-competitive practices. The competition law (Article 39 of Law Decree No. 211 of 1973) gives FNE broad powers to request information deemed necessary during its investigations. Under these powers, FNE can request data, documents, and information from: i) private parties, meaning individuals or legal entities; ii) public entities, including officials, public agencies and service, municipalities, or companies in which the State, or any other companies related to the State, have equity, representation, or participation. Information can be requested from entities in two different capacities: as targets of the investigation or as third parties. The FNE also has the power to collect and examine documentation, accounting information and any other material that it deems necessary. The FNE can request reports from any technical agency, such as CMF, and hire the services of experts and technicians. Furthermore, the FNE can request oral or written depositions from any individual, representative, administrator, advisor, etc., from any entity that may have knowledge of relevant facts under investigation, as well as any other person who has executed and celebrated agreements of any nature that may be relevant to the case. Private parties that do not comply with requests for information or do not appear after been duly summoned to depose can be fined by the TDLC. In addition, if parties obstruct investigations, they could be placed under arrest for up to 15 days if the FNE proposes this measure to the TDLC and the latter gives its authorization. Also, regarding cartel investigations, the FNE can request judicial warrants to conduct dawn-raids, get phone logs and wiretaps. Search warrants can include both companies’ premises and private residences of individuals. 28 A general rule exists that any agency that find out evidence about breaking the law in any subject not under its sanction perimeter, has to send the information to the pertinent agency 32 CHILE The FNE also collects evidence in cartel cases using its leniency program, an important tool for detecting cartels. 31. FNE uses its powers proactively and Chile has seen a significant number of competition investigations and advocacy initiatives in the financial sector, several of which triggered pro- competitive legal changes. Over the past decade FNE carried out 18 investigative processes in the financial sector. Five of them were cartel investigations and 13 investigations regarding alleged abuse of dominant position. Additionally, FNE conducted several advocacy initiatives related to competition concerns in the financial sector. Some of these processes were actively pursued by the FNE while in other cases, TDLC requested the FNE to inform about certain measures, regulations or other matters as requested by third parties. The number of such investigations processes is higher than in most LAC peers (see Table 2), highlighting the pro-active role played by FNE. Further, several of the investigations triggered regulatory and legal changes. Recent examples include the updated law on mortgage-related insurances (Law 21,314) or the transition from a three party to a four-party scheme in the card payments market (see paragraph 39). Box 4: Competition advocacy initiatives in the Chilean financial sector - Collateral credits (pawnshops). In 2014, FNE presented a report in response to a request made by a private financial service provider, to regulate collateral credits, which was a state monopoly up to that date. TDLC recommended to allow private parties into that activity and to properly regulate it, adopting some safeguards. - Stock market exchange. In 2015, FNE promoted a process to recommend the amendment of de Chilean regulation, named “Regulatory Recommendation File Article 18 N ° 4 of the D.L. N ° 211, on stock intermediation”. The goal of this process was to ultimately establish the mandatory interconnection between stock exchanges, which was finally approved by congress in 2020. - Card payments market. During the last years, the FNE participated in many different procedures regarding this industry. Between 2014 and 2017, the TDLC analyzed the case "Regulatory Recommendation File No. 20-2014 TDLC on the services associated with the use of universally accepted credit and debit cards as means of payment", which concluded with the Proposal for Regulatory Modification N° 19/20179. The recommendations seek to regulate the processes involved in card transactions (issuing, acquiring, and processing activities), as well as promoting competition in the acquiring function (see paragraph 39). - Mortgage-related insurances. In 2019, the FNE concluded an investigation that included a recommendation to adjust the regulation of the mortgage-related insurance biddings. The recommendations were incorporated in a recent law (Ley 21.314, April 13th, 2021). Source: FNE 32. Nevertheless, authorities need to remain vigilant to detect unilateral conduct or anti- competitive practices and certain practices/dynamics discussed with market operators might raise concerns and warrant further investigation. During the mission, market participants identified 33 CHILE certain practices that may raise concerns if it would be determined that the entities conducting them hold a dominant position. Examples include the reluctance of a dominant retail chain, which is linked to a credit card issuing financial institution, to accept prepaid cards, or the practice of retailers to offer discounts exclusively for users of a credit card issued by related financial institution. In addition to assessing if the involved financial or real sector entity enjoys a dominant market position, the analyses should also capture the extent to which potential efficiencies may offset the negative effects of these practices. In this regard, an empirical assessment is required of the specific market conditions, contextual factors (e.g., the level of financial education of the customer to assess the ultimate costs for discounts through high credit card fees) as well as the efficiencies generated by the practice – especially when the practices lead to better contractual conditions, drive to lower prices or foster innovation/development of new products. Merger review process identified competition concerns twice and imposed remedies that ultimately blocked the merger 33. The merger review process resulted twice in the imposition of remedies which ultimately stopped the mergers. Authorities reviewed several mergers in the financial sector over the past decade. These included major bank-bank mergers, such as the merger between Corpbanca, and Banco Itau Chile as well as the merger between BBVA and Scotiabank Azul (see paragraph 9). Additionally, several mergers/acquisitions between banks and non-bank financial institutions, primarily insurance companies, were reviewed. In these cases, FNE approved the mergers without constraints or remedies. However, in two mergers affecting financial sector entities, FNE requested remedies that ultimately discouraged the interested parties from pursuing the merger. The first case involved three large banks intending to create a new company for the operation of ATM machines. FNE’s review discovered possible anti-competitive effects of the merger and the competition authority requested changes that ultimately resulted in withdrawal of the merger application. The second case involved the planned acquisition of Servipag, a payment management company, by a large bank. As Servipag was owned by two other large banks, FNE prohibited the deal as it would lessen competition substantially and result in the risk of coordinated effects. In the Latin America context, FNE’s decisions to impose remedies on mergers in the financial sector, stand-out as competition authorities in the region only rarely impose remedies on mergers in the financial sector (see Table 2). 34 CHILE Table 2: Advocacy and enforcement activities in LAC peer countries ANTI-COMPETITIVE PRACTICES MERGERS ARGENTINA • Six investigations, no sanctions • One of the investigations concluded in the imposition of remedies (payment systems) BRAZIL • Investigation into foreign exchange • Remedies were imposed in market for collusive practices mergers in the payment systems market. • At least four mergers have been reviewed. COLOMBIA • One investigation • No mergers have been blocked and no remedies were imposed MEXICO • Investigation related to collusive practices by seven banks for manipulating Mexican sovereign bonds prices (2019) PERU • None • No mergers have been blocked URUGUAY • Two investigations regarding collusive practices in the credit card market. No sanction Source: WBG, 2020a. ‘’Competition in Retail Banking Services in Latin America’’. September, 2020. P. 5. Available at: https://openknowledge.worldbank.org/handle/10986/34444 III. Financial regulation and infrastructure 34. Competitive dynamics in the financial sector are strongly affected by the regulatory framework as well as the accessibility and efficiency of financial infrastructure. The financial sector displays a whole array of classical market failures ─ externalities, asymmetric information and market power ─ that have historically led to prudential regulation aimed at making the system safer and protecting small investors. However, many regulations, often unintentionally, also affect competitive dynamics, for example by facilitating or restricting market entries or influencing businesses’ strategy options and the costs to compete in the market. Conversely, also the lack of clear regulations and standards can affect competition by creating uncertainties and loopholes that might be exploited for competitive gains. A second form of public intervention that affects competitive dynamics is the provision of financial sector infrastructure. Financial sector infrastructure refers to the rules, standards and institutions that enable efficient and effective financial intermediation as well as the technical systems through which payments are made. It includes, among others, credit, and broader information reporting systems as well as payment systems. Fair and equal access to financial sector infrastructure is an important prerequisite for competition in the financial sector. 35 CHILE Severe shortcomings in the credit information infrastructure unlevel the playing field across and even within types of credit providers 35. Equal access to credit information is of crucial importance to enable competition in lending markets. In order to make informed lending decisions credit providers require information on defaults and late payments (negative credit information) but also on on-time loan repayments and the original and outstanding amounts of loans (positive credit information). A credit reporting system that distributes only negative information penalizes borrowers who default on payments but fails to reward borrowers who pay on time. Sharing information on reliable repayment allows customers to establish a positive credit history and improves lenders’ ability to distinguish good borrowers from bad ones. It also ensures that a credit reporting system will include high-risk borrowers that have accumulated significant debt exposure without yet defaulting on any loans.29 Unequal access to credit information unlevels the playing field in lending markets as it allows lenders with access to information to skim the market for good borrowers and price risk competitively while lenders without access to information are left with higher risk clients and non-efficient prices. 36. Access to negative credit information in Chile is generally open to all financial entities, but its depth is limited. Negative credit information covering delinquencies, late payments, and arrears on most lending products is primarily recorded by the Santiago Chamber of Commerce. This information is then shared with the private credit bureaus operating in Chile. The credit bureaus are not regulated and can share the negative information with all interested parties, including banks, non- bank lenders and FinTechs. However, the underlying data are subject to certain restrictions that reduce their depth and reliability. For example, the dated Data Protection Law (Article 17 of Law 19,628 of 1999 amended by Law 19,812 of 2002) prohibits the recording of debt data from utility or telecom companies. Additionally, twice over the past two decades (in 2002 and 2012), laws were passed that reduced the depth of negative credit information by deleting information on defaults below a certain value threshold. A similar law is currently discussed and its implementation would present a further significant blow to the depth of credit information. 37. Positive credit information is patchy and exclusively available to banks and a few selected non-bank lenders. Banks, connected SAGs, credit unions regulated by CMF, and going forward independent casas comerciales30, submit positive credit information on outstanding debt of individual borrowers to the CMF, which compiles the data in its consolidated debt database. Within the CMF database the information is aggregated at the individual level, meaning that some details about the debt composition, payment schedule and creditors are lost. CMF shares the consolidated debt data with the reporting entities (through the so-called R04 “Deudas Consolidadas del Sistema Financiero” report). Other non-bank lenders do not submit information to the CMF database and, as stipulated by the Banking Act (Article 14), are also not allowed to receive the information. This means that the CMF database is incomplete as it misses information on debt owed to non-bank lenders, as well as for example, data on mortgages extended by real estate developers or insurance companies. 29 IFC (2014). Establishing a Sound Credit Reporting System. 30 Following amendments to Article 14 of the Banking Act through Law 21,130 and the issuance of Circular No. 2,294 in September 2021. 36 CHILE The depth and completeness of credit information is further reduced by requirements in the Data Protection Act (Article 17 of Law 19,628 of 1999 amended by Law 19,812 of 2002) that once debt is repaid, it can no longer be recorded. Lenders thus only have a snapshot of outstanding debt but no comprehensive credit history. The preferential access to credit information for banks also unlevels the playing field against those non-bank lenders than cannot access the database, putting them at a disadvantage when making credit decisions. Like several non-bank lenders, FinTechs do not have access to positive credit information and this has been cited as a reason why P2P lending models have not yet been implemented in Chile. 38. Recent regulatory changes help to address inequalities in access to information within the non-bank lender segment but further progress is needed. In opening access to the CMF database (and extending reporting requirements) to independent ‘retailers’ (Amendment to Article 14 of the Banking Act through Law 21,130 and Circular No. 2,294) CMF recently improved the coverage of credit information and addressed a major competitive distortion that has unleveled the playing field within types of the non-bank lending segment. Currently – the changes will on be fully implemented only after a transition period ends in June 2022 - a casa comercial that is directly linked to a bank (as an SAG) gets access to the CMF database through its bank, while a casa comercial that is not part of a bank does not have access. This creates problems for the independent non-bank lenders that do not have sufficient data to make well-informed lending decisions and suffer from a ‘lemons problem’ as weaker clients go there knowing that their credit history was not available to the lender, causing higher NPLs. The information asymmetries can also contribute to high interest rates in the non-bank lending segment. Non-bank lenders linked to a bank can skim the market (i.e., skimming the low-income segment for relatively creditworthy individuals) and charge them a high interest rate. Similar problems exist, and are not addressed by recent regulatory changes, in the FyL segment, where bank linked FyLs still enjoy better access to credit information than independent FyLs. Authorities are aiming to create a new credit registry that would increase the set of reporting entities and include positive and negative credit information. The bill of law to establish this consolidated debt registry is currently discussed in Congress. 31 Continued progress towards the creation of such a consolidated debt registry accessible to all lending institutions is highly recommended as improved and non-discriminatory access to credit information remains necessary to facilitate fair competition in the lending market. This should be accompanied by measures that ensure the quality and safety of data from all reporting and receiving entities. Authorities implemented significant pro-competitive reforms in the card payments market, but challenges in the implementation threaten to dilute the envisioned impact 39. A series of competition procedures triggered the transition from a three-party to a four- party card scheme. Card markets can be structures as a three-party system, where the acquirer and issuer are the same entity, or four-party schemes, where these roles a performed by separate entities (see Figure 12). In most countries in the LAC region (i.e., Mexico, Argentina, Colombia, Uruguay, and Brazil) the four-party schemes are predominant, and their adoption has been promoted to increase 31 https://www.camara.cl/legislacion/ProyectosDeLey/tramitacion.aspx?prmID=15234&prmBOLETIN=14743-03 37 CHILE competition. Chile was long an outlier by relying on three-party scheme and only one entity, Transbank, acting as acquirer by mandate of banks. Transbank is a private SAG and was founded in 1994 as a joint venture between the major banks in Chile. It is owned by 11 banks and Chile’s top -6 banks have an ownership share of more than 98 percent. The monopoly role of Transbank, as well as complaints of merchants of discriminatory merchant discount rates, triggered multiple investigations by the FNE and procedures in front of the TDLC over the past decade. In 2017, the TDLC issued the Proposal for Regulatory Modification N° 19/2017 to regulate the processes involved in card transactions (issuing, acquiring, and processing activities), as well as promoting competition in the acquirer market. Following the TDLC proposal, the Central Bank published regulations (Compendium of Financial Regulations Chapters III.J.1 and Chapters III.J.2) that promoted and regulated the transition to a four-party card scheme. The transition to the four-party system was finalized in March 2020. Figure 12: Card Schemes Three-party scheme Four-party scheme Source: World Bank (2020), Competition in Retail Banking Services in Latin America 40. The four-party scheme holds promise to increase market entry and competition in the acquirer segments, but problems with the pricing structure need to be resolved. The new four- party scheme has yet to unlock strong market dynamics and competition in the acquirer segment. Four new acquirers entered the market, as some banks choose to create their own acquirer and one international brand joined, and the market share of Transbank decreased to around 85 percent, but new acquirers struggle to achieve profitability. One reason for this is that between March 2020 and September 2021, Transbank’s prices were frozen -pending a TDLC review of the proposed price stricture – at commercially non-viable levels for a sub-set of merchants with high volume of sales, that caused losses for Transbank and made it challenging for new acquirers to generate positive profits. Additionally, the interchange fees, determined by the international card brands such as Visa or Mastercard, which must be paid to the issuer of the respective card were close to the full merchant discount rate, reducing the scope to generate profits. FNE initiated a process (File No. 483-20) to evaluate the necessity to regulate the interchange fees established by the international card brands 38 CHILE and presented a report which evaluated different scenarios, to assess the impact in the Chilean payment card industry, according to the type of regulation, and the amount of the interchange fees. In August 2021 a committee with members designated by FNE, CMF, Central Bank and Ministry of Finance was established (through Law 21.365) that has the task of setting limits to interchange fees with the result expected for February 2022.32 Updates to the legal and regulatory framework for FinTechs are necessary to enable digital operators to enter and compete in a fair and safe way 41. The legal framework has not kept pace with rapid technological developments and most FinTechs operate outside the regulatory perimeter. In contrast to several Latin American peer countries, such as Mexico, Colombia or Brazil, Chile does not have a dedicated regulatory or licensing regime for FinTechs meaning that the vast majority of Chile’s almost 200 FinTechs are outside the regulatory purview of CMF. The lack of minimum standards and supervision complicates the growth of new business models as clients and investors may struggle to differentiate between trustworthy and non-trustworthy operators. This can preclude operators with new business models from competing with conventional operators regarding their networks/service. It also creates risks related to cyber-security, fraud, and AML/CFT as well as tensions with incumbent financial institutions (see paragraph 12). The lack of rules also applies to the activities of BigTechs in the financial sector, posing risks that BigTechs leverage their dominance in other markets and adjacent revenue streams or data to adopt aggressive pricing strategies and potentially anticompetitive practices to gain market shares in the financial sector. Since no clear rules are established that regulate the permissible activities of FinTechs or safety protocols, banks had in some instances chosen to act unilaterally by closing the accounts of FinTechs and blocking them from using data scrapping technologies. Such issues, however, should not be left to self-regulation by banks and FinTechs, as these actions can be misused to suppress competition and instead require rules and interventions by the authorities. 42. Cognizant of these challenges, authorities are working on implementing a new FinTech bill. The proposed FinTech bill, developed by CMF and the Ministry of Finance, seeks to extend the regulatory perimeter by bringing several types of FinTechs, such as crowed-funding platforms, alternative trading platforms, or credit scoring platforms, under the supervision of the CMF and requiring operators to obtain a license from the regulator.33 The proposal also establishes a set of minimum requirements regarding risk management and reporting, as well as a minimum capital of UF 5,000 (~US$ 188,000). The proposed law states that the requirements should be applied in a proportional way that reflects the risks inherent to the particular activities carried. As part of the legal updates authorities also plan to allow non-bank financial institutions to use the services of SAGs. This is an important aspect from a competition perspective as it opens the access to certain parts of the 32 While the current process is still ongoing, the Committee published the first limits to interchange fees, which are temporal and binding. These limits will enter into force after 45 working days from February 5, 2022. 33 https://www.cmfchile.cl/portal/principal/613/articles-46983_doc_pdf.pdf; https://www.cmfchile.cl/portal/principal/613/articles-25860_recurso_9.pdf 39 CHILE financial sector infrastructure (for example in payments systems, where Transbank is an SAG) to non- bank institutions, including FinTechs. 43. The proposed Fintech Bill also includes an Open Finance Framework, which holds promise to solve some deficiencies regarding access to credit information and level the playing field between different types of financial institutions. The Open Finance Framework34 proposes to establish a mandatory system for sharing customer financial information between financial institutions and eligible third-party providers in a way that ensures the safety and privacy of the underlying data. By opening and broadening access to data it can play an important role in a mitigating some of the competitive distortions stemming from the shortcomings in the credit information system (see paragraph 37) and help to promote the entry of new financial service providers. The mandatory requirement to share information is welcome from a competition perspective as it alleviates concerns that large incumbents, which concentrate most of the customer information, boycott the system and dilute its impact. The proposal includes additional competition safeguards regarding non- discriminatory access and interoperability (e.g., demands for authentication, data quality, stability service) as well as limits regarding the cost recovery of information requests. While the proposal to initially require only institutions under the regulatory purview of CMF to participate in the Open Finance framework is understandable from a practical and implementation point of view, authorities might eventually consider to also include other non-bank credit providers, such as cajas de compensacion, to provide a level playing field for all credit institutions. 44. The proposed FinTech Bill and Open Finance Framework are very welcome, but the long implementation time calls for additional interim solutions. The parliamentary process for the implementation of these activities started in the second half of 2021 – the Government submitted the FinTech bill to the Congress in early September 2021 and as February 2022 it was in the second constitutional stage of congressional discussion– but it is expected that it will take some time before the new frameworks are effective. It is thus important that interim solutions, e.g., voluntary guidelines issued by the supervisor, are considered to ensure sound competition and development of the FinTech sector until a comprehensive legal framework is in place. Interest rate caps may limit firm’s choice of strategic variables and their impact on financial inclusion and consumer protection should be assessed 45. Changes to the interest rate caps in 2013-2015 had a strong impact on market dynamics.35 Chile had several versions of interest rate caps over the past decades, but the most recent significant change came in late 2013 when the enactment of Law 20,715 tightened restrictions.36 The policy change affected both the definition of loan size brackets for interest rate caps and the formulas 34 https://www.hacienda.cl/noticias-y-eventos/noticias/ministerio-de-hacienda-anuncia-el-ingreso-del-proyecto-de- ley-de-innovacion/lineamientos-para-el-desarrollo-de-un-marco-de-finanzas-abiertas-en-chile-con 35 For a more detailed assessment of the impact of interest rate caps on financial inclusion, see TN on Financial Inclusion. 36 The law covers most credit operations more and sets interest rate caps (called Tasa Maxima Convencional, TMC) that vary based on the loan size. The limits are time-variant as they are calculated as a spread over a market benchmark rate. 40 CHILE for their calculation. When initially implemented, the changes stipulated by Law 20,715 led to a significant reduction in the interest rate cap particularly for small loans. According to Cuesta and Sepúlveda (2021)37, interest rate caps for loans smaller than US$ 8,000 decreased by between 17 percentage points and 24 percentage between 2013 and 2015. This had a strong impact on the market as several banks, which had established dedicated units that provided unsecured credit to high-risk clients, divested from these segments. From a competition perspective, the fact that the caps apply to all credit issuing entities, while proportionality is applied in the sense that lower loan volumes have higher ceilings, limits some of distortions. Nevertheless, interest rate caps present a significant public sector intervention that limits strategy options for financial entities and thus affect competitive dynamics. In addition, interest rate caps may reduce the overall supply of credit and impede efficient risk-based allocation of capital, disproportionately affecting poorer borrowers.38 Some stakeholders interviewed during the mission voiced concern that the ceilings prevent banks from expanding beyond their low-risk client base and limit the ability of microfinance entities and FinTech lenders to reach un-banked parts of the population. In any case, using the interest rate caps as an active policy tool and reducing the level of the caps, as currently discussed, should be avoided. Also, further improvements in areas such as financial literacy, consumer protection and credit information can help to protect consumers from usury and present less distortive alternatives to interest rate caps. A simple mechanism of screening for and assessing the potential competition impact of new regulations through a regulatory impact assessment can help to ex-ante identify unintentional competition effects 46. Performing ex-ante regulatory impact assessments (or RIA) for new laws and regulations, including their impact on competition has become a critical tool to foster regulatory efficiency in many jurisdictions. Lack of mechanisms for the simplification and evaluation of regulations, in particular of a systematized analysis of the competition impact of financial regulations (Competition RIA), could be preventing regulators from assessing or tackling the potential negative impact on market dynamics of government interventions. Regulation geared to tackle a market failure in the financial sector might have unintended consequences from the point of view of competition. A systematic regulatory impact assessment of competition can be critical to identify potential concerns in rules, guidelines or broader interventions and design less distortive alternatives, when compatible with prudential regulation. Even if no alternative is found and the original regulation is implemented, for example due to the importance of its intended prudential impact, the RIA process still gives authorities valuable insights into the likely impact on market dynamics. Such a simple competition RIA could, for example, be included as part of the existing impact report that CMF publishes for the public consultation of regulatory proposals. It is important, however, that the competition analysis does not weaken CMF’s key focus on financial stability and prudential aspects, which is and should be its main task. 37 Available at: https://siepr.stanford.edu/sites/default/files/publications/21-047.pdf 38 For a comprehensive analysis see Calice, P., Diaz Kalan, F., and Masetti, O. 2020. “Interest Rate Repression Around the World”. 2020. Available at: https://openknowledge.worldbank.org/handle/10986/34672 41 CHILE D. Appendix Box A 1: Decomposing bank net interest margins An accounting decomposition of bank net interest margins (the value of a bank’s net interest income divided by assets) can be derived from a straightforward accounting identity: Before-tax profits to assets (BTP/TA) = After-tax profits to assets (ATP/TA) + taxes to assets (TX/TA). From a bank’s income statement, before-tax profits must satisfy the accounting identity: BTP/TA = NI/TA + NII/TA – OV/TA – LLP/TA where NI is net interest income, NII refers to noninterest income, OV stands for overhead costs, and LLP refers to loan loss provisioning. The identities above allow for a decomposition of net interest margins (NI/TA) into its components: NI/TA = ATP/TA + TX/TA − NII/TA + OV/TA + LLP/TA Demirgüç-Kunt and Huizinga (1999) and Beck and Fuchs (2004) follow the identities above to conduct an accounting decomposition and an economic analysis of the determinants of bank net interest margins using data for 80 countries between 1988– 95, in the first case, and focusing on 38 banks in Kenya for the year 2002, in the second case. To the extent that high spreads are explained by high profit margins, these studies infer that lack of competition could be a factor. In the economic analysis of spreads, Demirgüç-Kunt and Huizinga (1999) regress spreads and profits on measures of concentration (as an indicator of competition) and conclude that, aside from other factors, lack of bank competition drives bank spreads and profits across countries. Similarly, Beck and Fuchs (2004) conclude that the high profit margins that explain part of the high spreads in Kenya are due to lack of competition in the banking sector. 42