Banking New Realities, New Challenges Eng V3

Banking: New Realities, New Challenges Impact on Emerging Markets Alejandro Dillon October, 2009

Agenda I The Financial Crisis II New Scenarios III The Future of Banking IV Looking Ahead 2

I The Financial Crisis II New Scenarios III The Future of Banking IV Looking Ahead

Overview of the US Financial Crisis The US house hold price bubble was the main cause of the problem The combination of both delinquency and the erosion of lending standards was a disaster – The latter eased when they should have tightened Ample liquidity and low interest rates fueled housing price inflation. The FED has great responsibility for these monetary excesses through interest rate relief and also the US Treasury by taking wrong decisions at crucial moments (e.g: Lehman case) Increased securitization channeled funds into the subprime mortgage market and masked the risks faced by investors. Credit rating agencies and the US SEC failed to warn buyers and investors of real dangers & rewards (e.g: Madoff case) Lenders moved into riskier lending – “reaching for yield” – at very easy borrowing parameters Banker were very eager to originate high yield “complex products” using “very cheap money” Credit default swaps (“CDS”), originally used to provide insurance against default on mortgage- backed securities (“MBS”) and Collateral Debt Obligations(“CDO’s”), became trading instruments for hedge funds and I-Banks. Most of sellers of CDS did not have the capital to cover a broad market downturn (e.g.: AIG) There was a “Spill over” effect from US to world markets, and the US crisis became global “We are at the end of an era” George Soros March-2008 4

The Vicious Cycle When the defaults started, financial institutions became reluctant to lend to each other around the globe. Intermediaries could not roll over their short-term borrowing. Markets started to freeze up world-wide achieving its peak in last quarter 2008. There was a vicious cycle, which drove further illiquidity. 5

The Big Problem: Global Savings Imbalance Accumulated 1980 2001 2007 2008 (US$ Bn) 1980-2008 In Surplus Japan 2,748 -11 88 211 157 China 1,522 0 17 372 440 Middle East 1,404 82 40 254 342 Germany 1,047 -14 0 250 235 Russia 614 0 34 76 102 Switzerland 597 0 20 43 45 Netherlands 523 0 10 47 38 Norway 444 1 28 62 84 TOTAL 8,899 58 237 1,315 1,443 In deficit United States -7,336 2 -385 -731 -673 Spain -773 -5 -24 -145 -154 United Kingdom -695 4 -30 -81 -45 Australia -529 -5 -7 -57 -43 Mexico -264 -10 -18 -8 -16 Italy -263 -17 -1 -51 -73 TOTAL -9,860 -31 -465 -1,073 -1,004 Source: Ricardo Arriazu & Asociados 6

Equity Markets – Comparative Performance NYSE: -36% Bovespa: -30% FTSE: -30% IPC: -20% Nikkei: -35% Merval: -30% Volatility, Uncertainty and Risk are not any more an intrinsic Emerging Markets problem, but now they are also present in OECD and in the rest of the World 7

The Great Dilemma USA China Vs. World largest Debtor Vs. World biggest Investor in US Treasuries US Citizen as the Largest Exporter Vs. World’s consumer of last resort in the current recession “Geitner’s tough times with China” Washington Post – June 14th, 2009 8

-Your credit card is ok, I’m just checking if your bank isn’t expired-

Market Realities As of first quarter of 2009, American banks lost approximately US$ 1 trillion and received over US$ 800 bn in new capital Citigroup HSBC JP Morgan 253 RBS UBS 215 165 120 116 19 92 91 12 34 -92.5% -57.2% -45.0% -90.0% -70.7% Aa3* Aa1* Aa1* Aa3* Aa2* Goldman Deutsche Santander Barclays RBC Sachs Bank 116 100 91 77 62 42 39 11 29 15 -63.8% -61.0% -87.9% -62.1% -75.8% Aa1* A1* Aa3* Aa3* Aa1* Market Cap as of second quarter 2007 (US$ bn) Market Cap as of first quarter 2009 (US$ bn) * Credit ratings of long-term bank deposits (Moody’s, as of fourth quarter 2008) 11

Government Intervention in the Industry: Nationalizations and Bailouts Effectively nationalized Bailouts (loans or Current Capital Situation Capital Raising (>50% stake) <50% stake) 5 (Northern Rock, B&B, Most Banks already nationalized - 2 (Barclays, HSBC) RBS, HBOS, Lloyds) 4 (Credit Agricole, BNP, State capital plan launched - - SocGen, Dexia) Bad bank rescue system for toxic assets - 1 (UBS) 1 (Credit Suisse) Government ready for intervention to 1 (Hypo Real Estate) 1 (Commerzbank) 1 (Postbank) nationalize Banks Further government capital unlikely 1 (Fortis Belgium) 2 (Dexia, KBC) - given Fortis and Dexia rescue First bank applied for government - - 1 (UniCredit) capital rescue (UniCredit) Swedish government announced scheme - 1 (Nordea) 1 (Swedbank) to strengthen banks’ capital Government fund available to boost 1 (Fortis Netherlands) 1 (ING) - bank capital 2 (Allied Irish, Bank of Top 3 banks bailed out or nationalized 1 (Anglo Irish) - Ireland) 8 (Bear Stearns, 6 (Merrill Lynch, Federal government launched the Citigroup, Bank of Citigroup, Bank of Troubled Asset Relief Program (TARP) - America, Wells Fargo, America, Wells Merrill Lynch, Morgan Fargo, JP Morgan, Stanley, JP Morgan, Goldman Sachs) Goldman Sachs) 12

New Players are challenging the leaders JP Morgan (JPM) vs. ICBC -China Price variation: 19 Sept 2008 – 19 May 2009 - JP Morgan: -23.9% - ICBC: 3.9% Market Cap (US$): - JP Morgan: 91 Bn - ICBC: 40 Bn Credit Rating Source: finance.yahoo - JP Morgan: Aa1 - ICBC: A1 Citigroup (C) vs. Santander (STD) Price variation: 19 Sept 2008 – 19 May 2009 - Citigroup: -81.1% - Santander: -38.3% Market Cap (US$): - Citigroup: 19 Bn - Santander: 42 Bn Credit Rating - Citigroup: Aa3 Source: finance.yahoo - Santander: Aa1 13

New Players Deutsche Bank (DB) vs. ICICI Bank Ltd -India Price variation: 19 Sept 2008 – 19 May 2009 - Deutsche Bank: -27.2% - ICICI Bank Ltd: 4.6% Market Cap (US$): - Deutsche Bank: 15 Bn - ICICI Bank Ltd: 16 Bn Credit Rating Source: finance.yahoo - Deutsche Bank: Aa1 - ICICI Bank Ltd: Baa2 Bank of America (BAC) vs. Itaú Price variation: 19 Sept 2008 – 19 May 2009 - Bank of America : -68.3% - Itaú: -20.3% Market Cap (US$): - Bank of America : 34 Bn - Itaú: 43 Bn Credit Rating Source: finance.yahoo - Bank of America: A1 - Itaú: Ba2 14

Structural Transformation in Financial Intermediation* 1945 1980 2008 Monetary authority 17% 4% 2% Commercial Banks 49% 32% 19% Savings institutions 9% 17% 3% Credit institutions 0% 1% 1% Insurance companies 17% 14% 10% Subtotal 92% 68% 35% Pension funds 3% 17% 16% Mutual & other funds 1% 3% 19% Government supported companies 1% 4% 5% Mortgages pool 0% 2% 7% Asset baked securities issuers 0% 0% 7% Financial companies 1% 5% 3% Mortgage trusts 0% 0% 1% Stock exchange houses 2% 1% 4% Finance corporations 0% 0% 3% Subtotal 8% 32% 65% Total 100% 100% 100% *Percentage over total assets - USA Source: Ricardo Arriazu & Asociados 15

Lessons Learned Sophisticated Financial Instruments (CDS, CDO, MBS, etc): Clearinghouse and proper regulation needed Banking leverage: Asset value support by capital requirements Regulation: Reform and supervision has to include changing market conditions in different regions Hedge Funds: Leverage, exposure and disclosure have to be monitored by third parties Madoff Case: No more safe heavens for investor confidence False decoupling: The world is totally interconnected Compensation: Bonuses based on the past year’s financial performance must give way to one that better aligns compensation to a longer timescale Rating Agencies: Limit conflict of interest by regulatory adjustment. Transparency: needed for products, players and markets Good and Bad Bailouts?: OECD 08 vs. EM ’90s Exchanges vs. Banks: new battle? Open debate: Insurance instruments ( USA) vs. Counter-cyclical regulation (Europe) “A full-blown financial crisis can exact an enormous toll in both human and economic terms. Financial disruptions do not respect borders. The crisis has been global, with no major country having been immune. The strong and unprecedented international policy response proved broadly effective; it averted the imminent collapse of the global financial system” by Ben Bernanke – Chairman, US Federal Reserve Board, August - 2009 16

The Rules of the Game within the Banking Sector Have Changed Pre-Crisis decisions During-Crisis decisions made on overall value made on cash Growth Solvency Cost efficiency Liquidity Credit risk Credit risk Liquidity Cost efficiency Solvency Growth 18

New Expectations and Needs have emerged in the Sector New Shareholder/Regulator New Customer needs expectations Focus on the core business Lower volatility Contribution to the domestic Simpler products economy Increased transparency Long-term orientation Multi-bank relationships Lower financial rewards Stronger balance sheets More accurately risk evaluation across the cycle Multi-currency risk management 19

Bankers: Back to Basics 5 C’s Credit Cash Flow Collateral Counterparty Credentials 20

New Commercial Banking Models Global specialists Global universals High Define the future sustainable core Build scale in home country and Divest non-core assets selectively in other key markets Upgrade risk management Manage default and credit risk in high growth segments Acquire / retain top talent as others restructure Tightly manage cash / liquidity to Level of maintain independence from government independence from government Local Banks “Back to basics” universal Define the “public service” mission Dispose of high risk / international Redefine incentives to motivate portfolio organization and retain talent Aggressively manage costs down Restructure portfolio and business Define boundaries of government model direction Plan for return to private ownership Policy Banks Low Low Size / depth of business and geography High 21

Wealth Management (Ex-Private Banking) Evolution Traditional Practices Tomorrow’s Practices Secrecy and asset preservation Value added solution and services Off-shore “dominant” culture On-shore driven growth Full client balance sheet (asset allocation as a key Investment focus (alternative & structured driver of success, advice adapted to broadened products, stocks, “beating the market”) product range) Product sales force Personalizing the portfolio advisory role Proprietary products Open architecture Research as generic service Research driving investment insights Transactional pricing Annuity pricing No IB deals Provide IB Advisory Service model adapted to the needs of each One fits all service model segment Stock in mature countries but higher net inflows Clear country focus from emerging countries Fragmented Industry More consolidated Industry (economies of scale) 22

New generation Investment Banks Old Model New Model Emerging local & regional competition with the Global dominance of US Investment Banks disappearance of US Investment Banks Low cost of capital & high leverage Higher cost of capital & reduced leverage Government will demand cooperation from Private Non government intervention Sector Focus on aggressive revenue growth Driven by risk-adjusted profitability Specialization (“Boutique approach to profitable Supermarket offering (“Be all things to all people”) business, products and clients”) Deal flow based on credentials New deals originated + executed by experienced teams Risk management as a support function Risk management as a competitive differentiator Excessively generous and volatile compensations More rational and stable payroll structures Operations through horizontal integration across Operating in vertical product silos businesses Seller of commoditized products Focus on advisory & value added services But more importantly concentrate on the “Relationship Concept with Client” 23

Different Institutional Goals among major participants Regulators Banks Governments De-leverage balance Capitalize net worth Provide credit to sustain sheet the economy Price risk correctly Increase credit margins Preserve access to on mass clients credit to mass clients Constitute reserves in Increase profitability on Keep prices for retail high cycles core activities and corporate clients stable Limit high-risk activities Adapt cost base through FTE reductions Sector to remain strong employer Will these issues create new tensions? 24

Challenges for Banking Sector Strengthening of capital adequacy in line with more stringent regulations. Global banks aim to reach a higher capitalization, focusing mainly on domestic markets and less on foreign markets Emergence of powerful regional banks with a strong local potential and global reach Systemic shocks accelerate process of consolidation, primarily in the USA Withdrawal of monetary stimulus/credit easing in the US and de-nationalization in the UK Tighter lending standards restore industry focus on traditional financial instruments Intensifying participation of the State and Monetary Institutions to manage systemic risk Higher participation of multilateral agencies in the corporate and government financing Re-launching of the “Relationship” and “Advisory” role in the banking industry “Several things were achieved, but there is still much to do” “The recovery will come sooner or later, depending on the cleaning of the banking sector balance sheets” Dominique Strauss-Kahn – Director, FMI April-2009 25

New M&A Trends in Emerging Markets CREDIT CYCLE Strategic (not speculative) buyers pave the way for an emerging buyer’s market MONETARY CONTEXT Low-interest rate environment favours corporate investing OWNERSHIP TRANSFER Sellers will be more willing to negotiate on an exclusive basis INTENSIFYING REGULATION Derivatives instruments in M &A deals subject to rigorous scrutiny EMERGING INVESTORS Sovereign Wealth Funds will act as key strategic investors ASSET QUALITY IMPROVEMENT Distressed-debt transactions will increase PURSUIT OF SIMPLICITY LBO-type transactions will be significantly reduced BRIC(+) PROMINENCE Increasing transactional flow lead by BRIC(+) countries There will be more investment banks acting regionally and locally than globally in the near future, due to the changing path of financial intermediation and to the implementation of the new models created 27

Latam Cross Border M&A Deals 2006-2008 M&A by Acquiror Nationality % of Total M&A Deal Value North America Mexico 60% 36% 4% Colombia 23% 72% 5% Chile 47% 48% 5% Europe Brazil 52% 39% 9% Argentina 35% 33% 32% Asia 0% 20% 40% 60% 80% 100% Local Foreign Cross Border Regional Cross Border Source: Thomson Financial 28

Conclusions Banking Industry needs “Our Mea Culpa”. Stronger and better capitalized financial institutions are needed. One World + Different Markets = New risks & opportunities. New Rules for a New Era: Still to be defined. Top credit names will capture the market available financing, with BRIC (+)issuers being a key relevant player. Emerging Markets will receive more foreign direct investments in strategic assets than investments in financial securities. Latam is a clear leading Player in this new scenario with new assets classes (e.g: Agribusiness). Latam should use the new Strategic M&A and the more Solid Capital Markets to consolidate corporate growth. “The crisis was created and extended around the world by the irrational behavior of white people with blue eyes who, before the crisis, seemed to know everything and now have proved to know nothing. The G8 has no longer a reason to exist now. Developing countries must have higher decision power in this new era” Lula da Silva-Brazilian President March 2009 29

Final Remark “Capitalism, with all its market mechanisms, has to survive…” “ No doubt about it. What I excoriate is that today there is only one incentive for doing business, and that is the maximization of profits…But the incentive of doing social good must be included…” Muhammad Yunus - Nobel Peace Prize 2006 May-2009 30

Banking New Realities, New Challenges Eng V3

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