Banco de Chile

SGO:CHILE

Earnings Call Transcript 2020-Q3

[Operator]

Good day, everyone, and welcome to Banco de Chile's Third Quarter 2020 Results Conference Call. If you need a copy of the press release issued yesterday, it is available on the company's website.

Today with us, we have Mr. Rodrigo Aravena, Chief Economist and Senior Vice -- VP of Institutional Relations; Mr. Pablo Mejia, Head of Investor Relations; and Daniel Galarce, Head of Financial Control.

Before we begin, I would like to remind you that this call is being recorded and that information discussed today may include forward-looking statements regarding the company's financial and operating performance. All projections are subject to risks and uncertainties and actual results may differ materially. Please refer to the detailed note in the company's press release regarding forward-looking statements.

I would now like to turn the conference over to Mr. Rodrigo Aravena. Mr. Aravena, the floor is yours, sir.

[Rodrigo Aravena, executive]

Good afternoon, everyone. Thank you very much for attending this conference call today. In the first part of this webcast, I'll present our view of recent developments in the business environment. Then Pablo Mejia, our Head of Investor Relations, will go over strategic advances and financial results achieved by our bank during the third quarter.

Let me start with our view of the economy. Please move to Slide #3. Several signs suggest the bottom of the negative cycle was seen in the second quarter of this year. Chile's activity is also improving when compared to most countries in the region, which is highly attributable to our sound fundamentals, strong policy responses and improvements in COVID-19 evolution. I'll go into greater detail regarding factors later on this presentation.

The chart on the top left shows the magnitude of this recovery. After the 43% annualized drop in the second quarter, GDP increased 21% in the third quarter. Consequently, the activity reduced its annual decline rate from 14% to 9% in that period. This rebound has been explained by higher dynamism in several sectors related to domestic consumption, which have also been influenced by the withdrawal of personal savings from pension funds as well as the implementation of other government support programs.

This potential turning point in the economic cycle has increased domestic prices. The CPI went up by 0.6% in September, which was well above the market consensus and from levels observed in previous months. Consequently, the annual inflation rate went up to 3.1% in September, rising 60 basis points from August as the chart on the upper right clearly shows.

As seen in most countries, the labor market has suffered the main negative consequences from this pandemic as shown on the chart on the bottom left. As a matter of fact, unemployment rate rose sharply from 7% in February to 13% in July. This deterioration resulted from the 20% and 15% decline in employment and labor force, respectively.

Nevertheless, some potential green shoots are taking place in line with the gradual but steady recovery of the overall activity. This can be seen in the bottom right chart, where the employment has been improving since August. These positive signs are highly attributable to the gradual lift of mobility restrictions due to the lower spread of COVID-19.

I'd like to briefly refer to this factor, which has undoubtedly had a key role in this recovery. Please move to Slide #4. In our previous conference call, we mentioned that Chile was under strict lockdowns since the second quarter of this year. As a result of these measures, we've seen a positive evolution in several indicators related to the pandemic, making possible the ease of mobility restrictions.

The chart on the upper left shows the drop in active cases of COVID-19 in Chile, with an impressive pickup in the number of recovered people. Additionally, the share of positive tests has remained at levels around 5%, well below other Latin American countries. Thanks to this, as you can see in the chart on the bottom left, local authorities have been reducing the number of areas in quarantine. While 54% of the population was under quarantine in July, this number went down to 19% in October. This change contributed to the greater mobility in the country as the bottom right chart suggests.

The impact on activity was greater. The proportion of GDP affected by the lockdown fell from 65% to 15% in the same period. This trend, together with strong fiscal and monetary policies and favorable copper prices, have been critical for this improvement. All these factors have led to better expectations for the future, which I'd like to discuss now.

Please move to Slide #5. We are aware of the unusual uncertainty that we face, not only in Chile but also in the world. That's why, in this particular environment, I'd like to emphasize 3 main assumptions that we take in our baseline scenario: First, we assume that social distance restrictions will remain most of the next year, which is consistent with the gradual pace of recovery in both GDP and employment. Second, we also assume the absence of further domestic shocks as we experienced last year. Finally, we also assume that copper price will continue providing support for the Chilean economy.

This table summarizes our forecast for this and the next year. We see a recovery in GDP to 4.5% in 2021 from a 5.3% drop this year, which positively compares with other countries in the region. The table on the right shows that, according to the IMF forecast, Chile will have the best performance on average in Latin America. We expect the inflation rates to remain around 2.8% this and the next year, still below the 3% target set by the Central Bank.

Since banks are a perfect reflection of the economy, this new normal has had significant implication in the financial sector, as we will discuss in the next slide. Please move to Page #6. The Chilean banking industry has shown an important resilience in this pandemic. Despite the crisis, which was accompanied by lower inflation, employment and interest rate, banks were able to adapt their strategies to deal with this scenario.

Total net income slightly increased on a sequential basis to CLP 473 billion in the third quarter, adjusted by Itaú figures. This result, however, was 19% below the same period last year.

Consequently, ROE fell from 12% in the third quarter to 9% in this period. In a broad sense, profitability was affected by the following factors: First, a weaker loan mix; second, higher cost of risk due to the new criteria to account for government-guaranteed loans and additional provisions; and third, the negative impact of lower inflation and interest rates as well as the flatter yield curves.

It's also important to pay special attention to the evolution of delinquency rates, which have remained at very low levels as the chart on the bottom left shows. Nevertheless, this should be a temporary situation since figures have been supported by specific factors. One of them is impact of SME's reprogrammed loans, which remain in the grace period. Another factor is impact of the 10% withdrawal from pension funds since, according to Central Bank, nearly 15% of these resources were spent in reducing past-due loans, as you can see in the chart on the bottom right. Therefore, it's reasonable to expect higher delinquency rates in the future after these effects end. Despite this complex environment, Banco de Chile was able, once again, to accomplish good results, not only in financial terms but also in strategic advances.

Please move to Slide 8. Banco de Chile has had a successful and proven track record of consistent and robust results. Since we aspire to continue being the most sustainable and profitable bank, we are continually reinforcing 3 key areas of our long-term strategy: digital transformation, efficiency and productivity as well as sustainability. We firmly believe that strengthening these strategic areas will allow us to support long-term growth and will help us in the future challenges that arise in the new business and social environment.

Please move to Slide 9, where we begin to highlight some of our initiatives in digital banking. The pandemic has accelerated how we use technology in our daily lives. This has pushed us to work harder and faster in all of our digital banking solutions in order to provide our customers with financial products and services they demand.

We are proud to announce that in September, we set a new standard for digital banking in Chile, officially launching our new digital 100% online onboarding bank account called Cuenta FAN. This is a far superior product when compared to what is available in Chile today. And thanks to this, our launch was a total success. In less than 2 months, we already have 90,000 new FAN customers. The demand from customers opening Cuenta FAN account nearly doubled the amount reached by our main competitor, as you can see on the top right on this slide. For instance, we launched a product in the first half of this year, and we reached almost the same amount of new customers but in a much shorter time frame.

There are many benefits to our account that are driving this demand. Just to name a few, a Cuenta FAN customer becomes a Banco de Chile customer, allowing them to receive all discounts and benefits of a regular client. There are also no entrance or maintenance fees, and this account grows with the customer. It starts as a debit account and later, if the client qualifies and desires, becomes a current account. As the FAN customer has additional financial needs, we can offer them other products, creating new cross-selling opportunities. Most of our new FAN customers are younger than 45 years old, and we are using this product to build closer relationships with people from these segments.

Before moving to the next slide, I'd like to mention that the cost of this account is very low when compared to a traditional account. At the origination, we don't require costly credit checks and extensive customer background reviews that could affect delivery times. It's also important to mention that ongoing costs for these accounts are marginal since we already have the installed capacity and back-office processes.

Please turn to Slide 10. As I mentioned in the previous slide, one of the main advantages of Cuenta FAN is that these clients have access to all discounts and benefits of a Banco de Chile customer. Our premium loyalty program includes exclusive discounts with the main delivery platforms such as Uber Eats, PedidosYa and Rappi. We also have a unique program called Big Five with discounts of up to 40% in big chains, including Starbucks, Papa John's and others.

In addition to this, we have partnerships for most demanded events in Chile and alliances with stores and services from a wide range of segments that go from technology, transport to telemedicine and leisure. This strong loyalty program is one of the fundamental drivers of the success of our Cuenta FAN and assists in increasing our relationship with customers to become their main bank account.

Please turn to Slide 11. Cuenta FAN is only part of our strategy to strengthen our digital experience at Banco de Chile. We are continually renewing, improving and rethinking how can we deliver our products and services better through the channels our customers are demanding. For this reason, we've been updating many of our front-office digital platforms, bringing more agility and security to our channels. One of the latest advances is our new web page that offers a superior customer experience and incorporates analytic tools. It's more modern, secure and inclusive.

We also integrated on our web page a heat map, which provides us with valuable information to understand our customer preference even better. In addition to this, we renewed our apps, Mi Banco and Mi Pago, with new technologies that allows for faster, easier and safer transactions. Behind our front-office improvements, we also have significant advances in our digital back-office operations. Undoubtedly, the pandemic accelerated our digitalization as in a short period of time, we had to deal with an important increase in the usage level of our digital channels.

To mention some numbers, we received 23% of the total pension fund withdrawal and processed 100% online over 400,000 loans in Personal Banking to support our customers' liquidity needs. All of these efforts are part of an ambitious plan -- or ambitious digital road map that aims to make our institution the benchmark in digital banking in Chile.

Now Pablo Mejia, our Head of Investor Relations, will continue to present the rest of our advances and Banco de Chile results.

[Pablo Ricci, executive]

Thank you, Rodrigo. Please turn to Slide 12. The successful implementation of our strategy has provided our customers with the best experience in the industry. Even during this challenging time, we have continued to innovate and strengthen our brand and lead in many different indicators, as you can see on this slide. For example, we continued to lead the industry in customer satisfaction with a wide gap to our closest competitor. This solid track record of customer experience has been provided through our proven ability to not only have the best customer service but also to offer the best products through the channels that our customers demand. I should mention that the survey shown on this slide for customer satisfaction is a fair representation of banking customers' opinion as a whole. These surveys use a more representative sample of banking customers and not predominantly use our own customers. It's also important to highlight that for a third year in a row, we were distinguished with the national award for customer satisfaction in 2020, as you can see on the right.

Another relevant point I want to mention is the strength of our brand. In many surveys, we ranked first. For example, we have posted, once again, the highest brand recognition in the Chilean industry, and we led with a very wide gap to our competitors in the surveys where customers are asked if they were to switch to another bank, which bank would they choose, as shown on the charts on the left.

We're also considered to be the safest bank in terms of security and solvency as shown on the chart on the bottom. This leading position in both customer experience and brand is extremely valuable in light of new regulations, where it will be much easier for customers to switch from one bank to another.

To date, we have more customers representing (sic) [ requesting ] information on switching to our bank versus customers requesting a change to another bank. We are confident that these attributes should assist us in maintaining the low attrition rate, as you can see on the chart to the right.

Please turn to the next slide, #13. In our 127 years of history, we have accompanied the development of Chile and supported the country, especially in more difficult times like today. Our commitment to be a sustainable bank is a fundamental pillar of our strategy. Along these lines, I would like to share some initiatives on this matter before moving to quarterly results.

Given our concern for our customers, we were the first bank to implement a national support plan for our retail banking and commercial clients. This plan included a series of special measures to support our customers so that they could cover their most urgent financial needs. We're deeply committed to supporting Chile's SMEs as we believe they are the driving force of our economy. In this line, we launched the fifth National Entrepreneur Challenge with more than 56,000 participants.

Furthermore, we have also implemented many actions in order to mitigate the consequences of the pandemic for vulnerable groups in Chile. Some initiatives we would like to highlight is that we delivered essential products to almost 9,000 vulnerable families all over the country and held a campaign that raised over CLP 16 billion to benefit elderly people affected by the pandemic.

All these efforts, among others, maintain our bank as the financial institution with the best performance in terms of actions taken during this health crisis, as seen on the chart on the upper right. Our sustainable business model was also recognized once again by the European, in the Global Banking and Finance Awards 2020 in the categories of Best Bank of the year, Innovative Digital Bank of the Year and Best Bank for Financial Inclusion in Chile. These awards acknowledge the relevant progress we have made in digital transformation and its contribution to our business.

In addition, Banco de Chile ranked first in general ranking of Merco Talento 2020, which positions us as the best company in the country to attract and retain talent. Finally, we are honored to be recognized for the outstanding crisis leadership by Global Finance. This clearly shows how we, as a financial institution, went above and beyond to assist customers, protect employees and provide critical support to the society at large.

Please turn to Slide 15 to begin our discussion on our results for this quarter. We recorded net income of CLP 88 billion with a return on average equity of almost 10%. Our lower bottom line was mainly the result of higher provisions attributable to our prudent and conservative risk management approach that aimed at setting adequate levels of provisions. We continue (sic) [ consider ] this approach particularly important today given the magnitude of the crisis we are facing globally.

Net income was also affected by a decrease in NIM, which was a consequence of a combination of factors, including lower CPI and the sharp decline in interest rates and loan mix. This was partially offset by strong cost control. Despite this, it's important to highlight that we still posted the highest year-to-date net income in the Chilean banking industry, and we have, by far, the highest level of coverage. Apart from having the highest profitability and the best credit risk indicators in the industry, we also outperformed the banking system in terms of capitalization levels.

Please turn to Slide 16. Operating revenues recorded a year-on-year decrease of 12%, principally due to unfavorable trends in inflation, interest rates, loan growth and fees. Specifically, inflation dropped 0.5% in -- when compared to the prior quarter, impacting noncustomer income. Also, given monetary policy actions taken by Central Bank, interest rates decreased sharply this year while yield curves flattened, which resulted in a lower contribution of our demand deposits to funding and less chance to benefit from term gapping. Additionally, we had a reduction in high-margin loan products as consumer loan demand shrank.

Second, the main driver of loan growth during the second and third quarters of 2020 was focused on the FOGAPE government-guaranteed commercial loans, which carry only a 3.5% interest rate. These effects were partially offset by better performance of our AFS and trading portfolios due to shifts observed in interest rates.

In this context, NIM fell from 4.1% last year to 3.1% this quarter, as you can see in the table on the bottom left. About 1/3 of this decrease was caused by the lower CPI we had this quarter. The remaining part is explained by the effect of the lower contribution of demand deposits to our cost of funding and term gapping given sliding interest rates.

It's also worth mentioning that, as was mentioned in previous calls, our net interest income has also been affected by the negative impact of mortgage loan renegotiations that took place in the second half of 2019 and the regulation regarding automatic payments of overdraft lines that went into effect in January 2020. The drop in NIM has also been explained by greater exposure to low-margin and low-risk assets such as the Central Bank short-term bonds used to comply with the reserve requirements linked to the strong increment posted by demand deposit balances.

Also since strict lockdowns began to be lifted by mid-August, our fee income has been impacted during the last quarters. Particularly, revenues from transactional services such as checking accounts, credit cards and debit cards as well as ATMs were down due to the lower transactionality and spending.

Similarly, fees linked to the loan originations such as insurance brokerage also decreased, while fees related to assets under management dropped as a result of market volatility that led customers to switch from higher-margin equity funds to fixed income. Nevertheless, the good news is that we have begun to see an improvement in different indicators across the bank that could imply the worst for fee income generation is behind us. Before moving on to the next slide, I want to highlight that we continue being the leading bank in the industry with a wide gap to our peers in fees and in net operating margin, as you can see on the charts to the right.

Please turn to Slide 17. Total loan growth reached CLP 31 trillion this quarter, increasing 6% year-on-year and up 1.5% quarter-on-quarter. Demand for loans, excluding COVID loans, improved slightly in the third quarter from the weak levels reported in the previous one, in line with the third quarter 2020 Chilean Central Bank credit survey.

This report showed that both demand and supply had improved slightly quarter-on-quarter for all retail loan products and that credit restrictions had been reduced to companies. Nevertheless, there is -- this was accompanied by a weaker demand for loans from the latter due to partly the high volume of COVID loans and the still uncertain outlook for the economy.

For Banco de Chile, most of the dynamism in loan growth was created by FOGAPE loan program, as shown on the diagram to the right. Specifically, total commercial loans grew CLP 2 trillion year-on-year, but CLP 1.8 trillion was related to these loans with government guarantees for companies with sales of up to $10 million per year. As a reminder, COVID loans were part of the government's stimulus package for companies that provided guarantees of up to 85% of working capital loans.

We are pleased that we have assisted our customers and Chile by taking part in this program. Most of these loans were provided to small and medium-sized enterprises, which explain about 21% of the growth, as shown on the chart, which explains the 21% growth level that's shown on the bottom of the slide for SMEs.

On the other hand, Personal Banking loans only grew 1.3% year-on-year and actually dropped 0.9% quarter-on-quarter, as you can see on the chart on the bottom right of the slide. This result is consistent with the subdued economic growth. This caused a reduction in household spending, which meant less demand for both consumer and loan -- consumer and mortgage loans. We expect that the dynamism of personal banking loans should begin to improve gradually in the next months if the economy recovers. In this regard, data revealed by the national chamber of commerce shows that household consumption, for instance, would be showing some signs of modest recovery.

Please turn to Slide 18. Our leading funding structure has been made possible through our ability to provide the best service experience that our customers value, and ultimately, establishes Banco de Chile as their primary bank account for both retail and wholesale customers. Over the past 12 months, our solid brand and soundness has provided us with strong increases in demand deposits, which rose an impressive 45% year-on-year and an equally remarkable 11% quarterly -- on a quarterly sequential basis.

Consequently, our funding structure has significantly changed year-over-year. Today, our demand deposits represent 32% of total funding, well above our peers, as shown on the bottom right chart. More importantly, DDAs held by nonfinancial counterparties, which are a stable source of financing, represents around 80% of the total amount. Also, we took advantage of the liquidity facilities provided by the Central Bank from which we obtained midterm funding denominated in pesos and bearing the monetary policy interest rate. These funding sources have mostly replaced time deposits held by financial counterparties, particularly in local currency. Our well-diversified funding base, as seen on the chart on the left, is undoubtedly an important competitive advantage for Banco de Chile.

Finally, our strong Tier 1 capital base of 11.6%, together with our superior credit risk ratings, allow us to place debt with good conditions, giving us a leading level of cost of funding of only 1.6% in local currency. We are confident that we can take advantage of the opportunities that will be presented during this period to strengthen our relationships with our current customers as well as continue increasing our share of wallet, especially through digital contact channels. Likewise, initiatives like the FAN account should allow us to keep expanding our customer base while bolstering our market-leading position in core demand deposits.

Before moving on to next slide, I'd like to mention that we are well prepared to face Basel III future phase-in requirements, which is in line with our historical guidance. Our solid track record of generating an attractive bottom line has been the result of our consistent and prudent risk policies that focuses on growing responsibly and sustainably over time.

Please turn to Slide 19. A key component of managing risk in Banco de Chile is the governance structure for this topic, in which the Board of Directors plays a vital role and actively participates in the whole process, including assessment, strategies and guidance of the bank for accepted risk levels, for developing and validating provision models as well as to define additional provisions.

As you can see on the chart on the left, cost of risk this quarter rose to CLP 113 billion, up from CLP 89 billion last year, but below the level posted of CLP 139 billion during the previous quarter. However, NPL continued dropping from 1.17% in the third quarter of 2019 and 1.33% in the prior quarter to a mere 0.98% this quarter.

The year-on-year rise in loan loss provisions was due mostly to the recalibration of our internal provisioning models for group-based evaluated portfolios in order to incorporate new information in the context of COVID with an impact of CLP 71 billion. This was partially offset by a release of additional provisions during the month of September for CLP 78 billion of the CLP 105 billion of additional allowances that we proactively recorded in the prior months this year. This is only a small portion of the total additional allowances we have booked on our balance sheet over the years. And as you can see on the chart to the right, we have, by far, the highest level of these reserves in the industry.

To note is that these allowances, even after this release, are 3x larger than our main competitor. This figure of cost of risk also includes the full impact of growth in COVID FOGAPE loans, most of them granted during the third quarter, and the full adoption of the provisioning treatment set by the regulator for these types of loans.

It's important to note that we continue to see a positive payment behavior from our customers and that this has translated into low levels of NPLs and the reduction of charge-offs. It's also important to note that we had a temporary rise in NPLs and charge-offs as a result of the weaker macro environment in Chile due to the social crisis that began in the fourth quarter of 2019. As a result of decisions that were undertaken during these events, our early overdue portfolio began to rise. Nevertheless, we adjusted our collection procedures and began an improving trend in overdue loans.

Despite this change, some overdue loans were not recovered. And in line with the temporary rise in NPLs, we saw a brief rise in regulatory charge-offs, which has now more than normalized. However, as we mentioned earlier in the presentation, we must pay close attention to how these indicators evolve as they are benefiting from the financial assistance that customers receive from both the government and banks as part of measures taken during the crisis. We can't rule out in the coming quarters to see a rise in delinquencies as these payment holidays and other benefits come to an end.

Nevertheless, our prudent risk policies have made Banco de Chile the most prepared bank to continue facing this weak cycle. All of what I've talked about demonstrates the quality of our portfolio, and our prudent risk management is bearing fruit during this difficult period. By having a consistent commercial and risk strategy, we have been able to grow our portfolio responsibly and profitably over the long run. We are confident that this risk approach should distinguish us among other banks in the coming quarters.

Please turn to Slide 20. During this quarter, we continued our focus on cost control as we believe that reaching efficiency in our operations is even more relevant in this challenging scenario. As you can see on the chart on the left, total operating expenses fell 5.9% year-on-year, equivalent to CLP 13 billion of savings. The drop in the yearly cost was driven by lower salaries as well as a reduction in administrative expenses, as shown on the chart to the right. Particularly, we had a reduction in salary expenses related to the lower severance indemnities from organizational restructuring that took place in 2019 as well as lower variable compensation as a result of the current situation.

As for administrative expenses, the main savings were associated with higher expenses in 2019, associated with the development and implementation of internal projects in order to improve our efficiency and deploy digital transformation initiatives. In addition, we introduced changes in our service models that allowed us to reduce costs in outsourced services.

Likewise, the use of more effective channels for advertisement -- advertising and customer loyalty enabled us to reduce marketing expenses. Thanks to our cost control efforts, we recorded a slight improvement in our accumulated efficiency ratio that reached 44.6%, clearly outperforming the average level posted by the industry that actually increased during the same period. We also recorded a positive indicator of expenses to total assets of 1.86% this quarter versus the 2.33% recorded 1 year earlier.

Please turn to Slide 21. Even though it's difficult to predict how this pandemic will evolve, since some countries are evidencing increases in COVID cases and a return to lockdowns, we clearly see some signs suggesting that the worst is behind us. As you can see on these charts, we have begun to see a gradual increase in origination for consumer mortgage loans as well as a steady rise in terms of new current account openings. We're also seeing a slight improvement in credit and debit card purchases. The low figures seen in prior months was due to the strict lockdowns and the low mobility in Chile, and this caused a significant impact to the credit origination as well as activity in our transactional products.

We are pleased to see a gradual normalization in these figures, and this should translate into better income generation as well as in the coming quarters. We are confident that these better perspectives for the economy, together with our superior competitive advantages, will allow us to continue being the best long-term alternative for our investors.

Thanks, and if you have any questions, we'd be happy to answer them.

[Operator]

[Operator Instructions] And the first question we have will come from Tito Labarta of Goldman Sachs.

[Daer Labarta, analyst]

A couple of questions. I guess, first, in terms of your margin, just to understand how we should think about the margins going forward. Or maybe to start, like how much of your margin is impacted by the FOGAPE loans? And how long are you thinking that will continue to impact your margins? Like how should we think about margins for next year? Do you think you can get some improvement in the margin or increase in the margin?

And then second question in terms of your provisioning and your cost of risk. I mean -- so do you feel that -- I think you've mentioned you provision now for everything. Do you think your cost of risk next year can really begin to come down or even in the fourth quarter? How do you feel about your provisioning versus kind of your expectations for asset quality going forward given that the real impacts on NPLs will only happen going forward?

[Pablo Ricci, executive]

Okay. Well, in terms of NIM recorded this quarter, a level of 4 point -- or 2019, I think it's important to go over a little bit where we're coming from. So in 2019, our NIM was around 4.2%. And year-to-date, in 2020, we recorded 3.5%. And in the quarter, 3.1%. It's important to note that if we look at the 2019 numbers, we have to take into consideration certain things that occurred. For example, there's 20 basis points we have to reduce from the level from last year, the 4.2%, because of the huge level of renegotiations of mortgage loans because the interest rates were very low, and that took place mid-2019 when customers began renegotiating.

So this, together with the implementation of a new regulation that obligates banks to pay off overdraft lines of credit when customers have funds in their accounts, affects our NIM by about 20 basis points. So in summary, for the 4.2% level that we recorded last year, in reality based on the new market conditions and regulations, it's closer to 4%.

So it's also important to mention some things that happened this year. So we have -- due to the huge amount of demand deposits that we received, this affects our net interest margins as well because we have to place those funds -- or a portion of those funds in high liquid assets. So that's about 10 basis points. So for the 3.5% that we recorded this year, if we adjust -- if we look at it on an adjusted basis, it should be closer to around 3.6%. So we're comparing 4% and 3.6%.

So if we look going forward, there's some things that we should take into consideration. First, inflation should return to the levels of 3% at some point in the future. For every 100 basis points of change in inflation, that's around 15, 16 basis points in NIM. Based on the current gap on our balance sheet, the low overnight rate of 0.5% is temporary.

So after this crisis is over, it's reasonable to expect that the long-term rates should move back up to the level of 3% to 4%, which is positive for margins, especially us, because we have a huge amount of noninterest-bearing liabilities under assets. For every 100 basis point change in the overnight rate, in the long term, this is something around -- when we say long term, 3 to 5 years, it has a benefit or impact of around 30 basis points, everything else equal.

And third, loan mix is super important because in terms of the commercial loans for the FOGAPE loans, they have a low interest rate. If you look at it in terms by segment, it brings down margins. But as a whole for the commercial loan portfolio, it has a higher interest rate than the average interest rate of our commercial loan portfolio. So by segment, for SMEs, SMEs have a higher interest rate because they have a much higher level of risk. But for the entire commercial loan book, it's actually positive for the -- for interest rates.

So what's happening -- more than that, commercial loans for the FOGAPE, what's occurring negatively is that the high-margin products such as consumer loans are decreasing around 12%, 13% for us in the industry. And also those SME loans that normally would grow aren't growing because customers took advantage of the FOGAPE loans.

So when we look forward, we should think that we should be able to have a better growth in consumer loans, high-margin products such as the consumer loans I mentioned and the commercial SME loans. And that should, in the medium term, return us -- maybe not -- it should return us to the levels higher than what we have today of the 3.5% adjusted. And the 4.2% would have to be other market conditions, long-term level. It's a different portfolio than we had before any regulations.

In terms of risk, I think some things that are important to mention is that the environment that we're facing is highly uncertain. It's something very new to us and the world. This crisis doesn't have an economic crude, and it's impossible to anticipate the impacts of the recession on asset quality. This is one of the reasons why it's difficult for us to provide guidance for the future. However, there's some essential things to keep in mind.

As we mentioned in the presentation, there's a gradual recovery in the economy for 2021. This is an important -- after this important contraction this year. So based on this, we recalibrated our risk models in order to reflect this better way to evaluate this current economic situation. So from a prudential point of view, it's undoubtedly much better to have these models that reflect the new normal in the economy. And that's why we use a portion of these -- or we being basically used a portion or reclassified a portion of these additional provisions that we had recorded throughout the year into this new model.

So we actually didn't release provisions. We reclassified these provisions, and our actual provision levels are actually higher than they were before than lower. So the net effect is actually an increase in provisions this quarter.

This change follows with other measures earlier in the year. For example, there's a significant increase in group provisions for companies that were exposed to sectors that were affected by this. So the individual loan book portfolio, we are very conservative in terms of that portfolio. We increased the provisions there. This is part of our proactive management for a risk approach.

And finally, I think some things to consider is that we have the highest coverage ratio, the very diversified loan portfolio, a proven track record of risk management. And we think that this will be key attributes that have -- that allow us to better preserve the value of the bank in the long run.

[Daer Labarta, analyst]

Okay. That was pretty clear. But just, I guess, on the cost of risk. And I know it's uncertain, but how normalized can 2021 be? Do you think maybe the first half of the year, cost of risk needs to remain somewhat elevated and second half, you can get back to normalized levels? I mean -- and I know it's difficult to predict, but just to help a little bit in the modeling. Is that the right way to think about it, maybe higher in the first half and lower in the second half, getting back to normalized levels in the second half?

[Pablo Ricci, executive]

I think it's difficult to estimate for how this will evolve, especially that there's a lot of government aid and different things have occurred in Chile. For example, the withdrawal of pension fund money, which has helped customers pay their loans. There's still payment holidays for the SME loan book, which comes due later on this year or beginning of next year. So there's still a lot of uncertainty which could happen, especially if we look at what's happening in Europe and other areas. A second lockdown makes it difficult. So probably before seeing an improvement, there will be still some uncertainty in the medium term before we get to normalized levels.

[Rodrigo Aravena, executive]

Yes. So I would like to add one thing here, Tito. We are not providing more guidance for the next year because there are very high uncertainty. So it's not clear, for example, how will be the relation between the employment recovery relative to the GDP growth. So what we've seen is positive signs in the Chilean economy, some green shoots, as we mentioned in the presentation, that since we have a very high uncertainty, we think that the most responsible from here is to not provide more guidance for the next year.

[Operator]

The next question we have will come from Neha Agarwala of HSBC.

[Neha Agarwala, analyst]

My first question is regarding the repayment behavior. Could you give us some concern, what percentage of the loans that you had reprogrammed actually came due? And what is the payment behavior of those loans?

And I'm still not quite sure what was the reason for releasing the -- some of the additional provisions given that you feel that there's a lot of uncertainty in the environment. So what made you take a step like that? And then I'll ask my second question.

[Pablo Ricci, executive]

In terms of the additional provisions, I think it's important to mention that those provisions are used for uncertain times. And what we did is we updated the models to take into consideration more of these market aspects that were occurring today and the actual provisioning models. So we could use -- so we've basically reclassified from one part of the book to another, but it really doesn't have -- the net effect this quarter was higher provisions, higher coverage ratio. So it was just something that was evaluated on how we could implement this methodology. And this was how it was considered the best method to record allowances for the bank.

[Rodrigo Aravena, executive]

It's important to mention as well that we have a new market scenario. Perhaps we have a new normal with different parameters. So it's very hard to imagine, for example, that the probability of delinquency rates in the future is the same today relative to the previous scenario. So what we are trying to do is to reflect, on a better way, the current economic situation, the current probability of default, for example, in the current economic model. So basically, this year is to adapt our models to the new normal in the economy. That's the main idea, Neha.

[Neha Agarwala, analyst]

Understood. And on the repayment behavior?

[Pablo Ricci, executive]

In terms of the repayment behavior, we've had very good repayment behavior from the customers that have had their loans being postponed. Today, most of the customers for the consumer loan book have already repaid. A portion of the mortgage loan book is repaid. And then we have the SME loans, which still have a little while to go for us and the industry because that's program of FOGAPE. But what it entails is that the customer that took a FOGAPE loan would have -- all the other loans at that bank would get a 6-month grace period.

So since this happened during the second quarter of the year, probably the end of this year, beginning of next year, we'll have more information on how that evolves. But what we're seeing today is our postpone book is performing better than the level of our total overdue loans of our average retail loan book prior to the COVID crisis.

[Rodrigo Aravena, executive]

It's very important to analyze how the economy will evolve in the future given the uncertainty. So far, it's been better than expected, but we have to be cautioned relative to the evolution of the economy in the future.

[Neha Agarwala, analyst]

Okay. My next 2 questions are -- first, on capital and payout. What is your expected impact on capital ratio from Basel III implementation next year? And do you expect any delays in implementation? Or it should happen early 2021? And what do you think about the payout ratio that you can maintain given that you have the strongest level of capital?

And my second question is more on the economy. We had the referendum recently. What impacts do you see from the constitution? Or how do you think this will -- it's a 2-year process, but how do you think it will impact -- the final impact would be on Chile?

[Daniel Ignacio Galarce Toro, executive]

This is Daniel Galarce. As you know, we don't have the old regulatory framework yet. I mean the Chilean regulator has published most of the specific regulations regarding Basel III. In fact, we just know the final norms for no more than 5 or 6 of them. So, so far, as we have mentioned in previous calls, regulations are quite similar to our first estimate.

So we don't see any significant deterioration regarding what we estimated in the past for the impact of Basel III on our capital ratios. Yet, the regulator has imposed or have phased in the implementation of Basel III starting in December 2021 until December 2025. So we have some time in order to commend any need of reinforcing capital if we believe that it's not enough. However, we are quite confident because we have taken steps in the past in order to bolster our capital base. As you know, in 2019, we issued subordinated bonds.

And also, we need to know how the new regulation will evolve and how the market will evolve in terms of additional Tier 1 capital. So we still have a lot of room in order to prepare our capital base and us in order to address the new regulation. We don't see significant deterioration in our capital ratios due to Basel III as long as the implementation is gradual, okay?

[Rodrigo Aravena, executive]

Neha, this is Rodrigo Aravena again. In terms of the impact of the potential new constitution, I think that it's very important to say that it's too early as to anticipate potential changes in the constitution as well as in the economy since it has to be discussed in the new body, and each article has to be approved by 2/3 of members of the elected body. Even though uncertainty in the process, we are aware of the importance of preserving those critical aspects that have been important in the development of Chile, but it has to be discussed in the next -- during the next year. It's important to keep in mind here that the ability of conducting this process with a discussion based on a long-term view that takes into consideration empirical evidence and also learns from international experience will be a positive factor in the discussion and, of course, in the future development of Chile. For now, we think that the most prudent thing is to wait for the discussions to be held in the process during the next year. So it's more prudent to wait for the discussion.

Having said that, I think that it's very important to keep in mind that Chile has had a very positive result in the economy during this year relative to other countries. In fact, according to the IMF estimates as well as the market consensus, consensus forecast, et cetera, Chile is expected to have the best performance on average during this and the next year as a result of the solid fundamentals that we have as well as the very active response from the Central Bank and the central government as well. So we are aware of the potential increase of uncertainty, but it's too early as to anticipate any specific impact coming from these discussions.

[Neha Agarwala, analyst]

Okay. Very helpful. Anything on the payout ratio?

[Daniel Ignacio Galarce Toro, executive]

Yes. Yes. Regarding payout ratio, we should maintain our dividend policy more or less over the next years. And actually, it has been very, very consistent over time.

[Pablo Ricci, executive]

Yes. I think it's important to mention, however, that this is something that's taken the side of the Board level, and we don't have information until January of this year on how this will evolve. So it depends on many different market factors. But in the long term, as Daniel mentioned, it should be similar to that level. But in the shorter term, we have to take into consideration what will happen in the short term and how our Board of Directors will decide to capitalize.

[Neha Agarwala, analyst]

Okay. So financially, it could be lower than 60%. That's not decided yet?

[Pablo Ricci, executive]

No. No. There's no decision today for the dividend that we'll pay in March 2021. It's still something that's being analyzed, under discussion, and it's something that the Board of Directors will review.

[Operator]

[Operator Instructions] The next question we have will come from Claudia Benavente of Santander.

[Claudia Benavente, analyst]

I have a question. Is it possible or fair to compare the changes that you made to the provisioning model to IFRS 9 that eventually Chilean banks will have to comply with? Do you believe that the increase -- important increase that you made on the consumer book reserves would be enough to comply with IFRS 9?

[Pablo Ricci, executive]

The important increase -- thank you, Claudia. Important increase in provisions, I think you have to take into consideration, it depends on the cycle and how this evolves and what point you're in. And the models in Chile don't only use nonperforming loans. So generally, the difference in accounting different to the reconciliations for the 20-F, for example. It is so large an impact like it is in other countries. So it's reasonable to expect that this would bring us closer to those levels if we've had to apply IFRS 9 in Chile today. But the model is different based on the different models I'm referencing.

[Claudia Benavente, analyst]

Okay. No, I just wanted to make sure -- because at the end, like you mentioned before that the change could translate into an expected loss base. So it could -- it should be kind of more similar to IFRS 9. So it probably can help you to at least comply with the new regulation in a way.

[Pablo Ricci, executive]

Yes. So it's -- for IFRS 9 and the 20-F, for example, it's around a similar level of the CLP 70 billion that we recorded. It's a similar level. Not the exact, but it's similar. So in terms if we had to apply it in the reconciliation, it would be -- the impact wouldn't be so significant anymore.

[Operator]

And next, we have Domingos Falavina of JPMorgan.

[Domingos Falavina, analyst]

Just want a quick recap. Everyone had -- I know it changes based on your balance sheet at the quarter, but like looking at your balance sheet today, 100 basis points of higher U.S. inflation, what impact would it have on either NIMs as well as on tax rate? And the ballpark estimates are fine, too, and I'm sorry if you mentioned that before. I couldn't join the whole call.

[Pablo Ricci, executive]

In terms of the gap on the balance sheet, we have about CLP 5.8 trillion gap on the balance sheet. It runs between CLP 5 trillion and CLP 6 trillion. So for a 100 basis point change, that changes net interest income between CLP 50 billion and CLP 60 billion, which is around 15 basis points in net interest margin and how we cap rate it.

So when you look at the effective tax rate, you have to look at 2 things. One is the offering because we have more assets in Europe than liabilities. We have a positive impact of higher inflation. But at the same time, the tax authorities use inflation accounting to calculate the price level restatement expense. So you have to take the net nonmonetary asset position. So we have more liabilities linked to the U.S. Then our assets linked to U.S., they are nonmonetary. So our assets are fixed. Our equipment, properties, et cetera, and our liabilities is equities. So you take basically the acquisition, multiply it by the inflation for the period, and that's your price level restatement loss.

So the calculation, generally, when it's running around 3% inflation, generally, Banco de Chile should be around an effective tax rate of 23%, 24%. As that trends to 0, it will be closer to...

[Operator]

Well, so no further questions at this time. We will conclude the question-and-answer session. I would now like to turn the floor back to Banco de Chile's management team for the closing remarks. Gentlemen?

[Pablo Ricci, executive]

Thank you for participating in this conference call. We look forward to speaking with you for our year-end results. Thanks.

[Operator]

All right. And thank you, gentlemen. This concludes today's presentation. At this time, you may disconnect your lines. Thank you, again, everyone. Take care, and have a great day.