Earnings Call Transcript - BCH Q1 2023

Operator, Operator

Good afternoon, everyone, and welcome to Banco de Chile's First Quarter 2023 Results Conference Call. If you need a copy of the management financial review, it is available on the company's website. Today with us, we have Mr. Rodrigo Aravena, Chief Economist and Institutional Relations Officer; Mr. Pablo Mejia, Head of Investor Relations; and Daniel Galarce, Head of Financial Control and Capital. Before we begin, I would like to remind you that this call is being recorded and that the 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 will now turn the call over to Mr. Rodrigo Aravena. Please go ahead, sir.

Rodrigo Aravena, Chief Economist and Institutional Relations Officer

Good afternoon, everyone. Thank you very much for attending this call, where we will review the main accomplishments of Banco de Chile during the first quarter of this year. We are very proud of the overall performance of our bank during the first quarter of the year. Once again, Banco de Chile led the industry in terms of profitability by posting a solid 22% ROE, thanks to its bottom line of MXN266 billion. The bank also maintained its sound capital position, reflected in 17% and 12.8% in Basel and CET1 ratio, respectively, while asset quality indicators remain healthy. This figure, coupled with our permanent leadership in customer service, only confirms the unquestionable leadership of Banco de Chile in the country. As we mentioned in our previous earnings release, we have divided this call into four main sections. In the first part, we will analyze the macroeconomic and financial environment we faced and our forecast for this year. Second, we will refer to our key strategic advances and accomplishments. After this, we will present a detailed analysis of our financial performance. And finally, we will move to a Q&A section. Let me start with the macroeconomic analysis. Please go to slide number three. Despite the recession that we have faced, as the upper left chart shows, the economy began the year in better shape, particularly the lower-than-expected decline of local activity, together with improvements in some key drivers for Chile such as cover prices allow us to expect a better-than-forecasted performance of the economy for this year. In the last quarter of 2022, the GDP declined by 2.3% year-on-year, mainly attributable to the substantial adjustment in domestic demand, which dropped by 7.6% year-on-year, principally driven by the 4.7% decline in private consumption. Even though it was the first negative year-on-year rate since 2021, it's worth mentioning that the slowdown began earlier in 2022 due to the normalization of several temporary factors that fueled the activity during the pandemic. In fact, as you can see in the chart on the other right, the activity level remained flat during all of 2022 with a figure in December below the levels seen at the end of the previous year. All in all, this confirms that the GDP didn't expand sequentially last year. Nevertheless, valuable information from the first quarter suggests that the bottom of this negative cycle has been left behind us. According to adjusted figures, the GDP reduced its pace of decline to 0.9% year-on-year in the first quarter from the 2.3% year-on-year in the previous period, an improvement on a sequential basis to explain this, as activity expanded at an annualized rate of 3.9%, achieving its first positive figure since late 2021. This marginal improvement has been explained by a greater contribution from non-mining activities, mainly services. In the labor market, there has been a gradual increase in the unemployment rate, as can be seen in the chart at the bottom left. In the first quarter, unemployment rose to 8.8%, 100 basis points above the figure posted one year ago. It's important to mention that this rise was driven by an acceleration in the labor force which increased by 3% to 5% year-on-year, surpassing the 2.4% year-on-year expansion in total employment. Higher employment resulted from a faster recovery in the participation rate rather than a deterioration in the number of jobs in the economy. Another positive event has come from external accounts suggesting an important narrowing of the current account deficit posted last year. The chart on the bottom right displays the trade balance posted a surplus of $7.5 billion in the first quarter, achieving the best figure in 16 years. This improvement was a consequence of two opposite forces; first, a rise in total exports, which increased by 11% year-on-year, led by the recovery in mining and industrial exports. Second, on the opposite side, imports fell by 16% year-on-year to $19.5 billion as a consequence of the 32% year-on-year decrease in consumer imports and 11% year-on-year fall in capital imports. As I said before, the slowdown in Chile has followed the normalization of several factors primarily related to economic policies. Please go to slide number 4 to analyze them. This slide highlights the role of tighter monitoring fiscal policies. In the chart on the other left, you can see how substantial adjustment in fiscal policy has been. Notably, in 2022 the fiscal expense was reduced by almost nine points of the GDP, measured as a change in the overall balance. This adjustment resulted from the surplus of 1.1% of the GDP last year due to the 23% decline in fiscal standing and higher revenues from the dynamism in 2021 and the extraordinary contribution from lithium. Consequently, Chile was one of the countries with the strongest fiscal adjustment in the world. The monetary policy followed a similar path, as seen in the chart on the bottom left. Between mid-2021 and November 2022, the overnight rate posted an unprecedented rise of 1,075 basis points from 3.5% to 11.25%, also achieving one of the highest adjustments in the world. The tightening in monetary and fiscal policies has made an important contribution to reducing the excess liquidity of the economy. As can be seen in the chart on the other right, the level of M1 money supply has decreased significantly since the end of 2021. As a result of this trend, M1 posted a 24% year-on-year decline in the first quarter after falling by 27% and 23% year-on-year in the fourth quarter and third quarter 2022, respectively, comparing to levels more consistent with its spread anemic tendency. Undoubtedly, all these trends contribute to reducing the wider macroeconomic balances seen during the pandemic. This normalization of the economy is a key source of stability in the long run, which has also contributed to the recent strengthening of the Chilean peso, as the chart of the bottom right displays. Now, I'd like to share our forecast for this in the following year. Please move to slide number five. We expect a total improvement in the Chilean economy beginning in the second half of this year, specifically, the combination of several factors such as the higher growth in China and better prices in the rest of the world, as well as the downward trend in inflation and the more supportive modern fiscal policies in the future allows us to move from negative year-on-year growth in the first half to positive figures in the second semester of this year. We changed our yearly forecast to minus 0.4% for 2023 from minus 1.4% in the previous conference call. On inflation, we foresee a headline CPI of 5% by the end of this year, down from 12.8% in 2022. The main drivers for this trend include the stronger currency compared to 2022 and the normalization of domestic demand. In this environment, we expect the Central Bank to reduce the interest rate from 11.25% to nearly 7.5% by the end of this year. However, given the important indexation in the Chilean economy, we acknowledge our bias in this estimate. Finally, it's worth mentioning the existence of several sources of risk that could affect our forecast. Given the strong integration of the Chilean economy, it's important to monitor the evolution of the main partners of Chile such as China and the United States as well as prices. Locally, the evolution of structural reforms, such as the institutional process, new tax and pension bills, and the development of sectoral discussions including the lithium proposal from the government are worth paying attention to. Now I'd like to discuss the main banking industry trends. Please turn to slide number six. The banking industry posted net income of MXN1 trillion this quarter, equal to an ROE of almost 15%, as you can see on the chart on the top left. This lower result was primarily due to the effect of lower inflation that reduced operating income, as shown on the chart in the middle of this slide and the negative effect of repricing of liabilities for certain players given their balance sheet mismatches. This was further impacted by a rise in the cost of risk, as you can see on the chart to the right that went from 1.1% in first quarter 2022 to 1.4% in first quarter 2023. Real loan growth has been less than expected due to the higher interest rate in the broader economy. Total loans contracted 2.4% year-on-year. Commercial loans decreased the most by falling 4.5% year-on-year, followed by consumer loans, which decreased by 5%. Only mortgage loans showed positive levels of growth. We expect that loan growth will gradually normalize as long as the economy recovers in the second half of this year. Finally, it's important to note that Chilean banking industry assets, in contrast to other geographies, have balance sheets of local banks that are mainly concentrated in loans, representing 61.5% of total assets. Instead, overall financial instruments, including derivatives, represent 17% of total assets, while the held-to-maturity portfolio only represents 3.8%. Consequently, the local banking industry is less exposed to financial events that have recently affected some banking players worldwide. Now I'd like to pass the call to Pablo, who will go into more detail about Banco de Chile's advances and financial performance.

Pablo Mejia, Head of Investor Relations

Thank you, Rodrigo. I'd like to begin with our main accomplishments in our key strategic projects. Please go to Slide number 8. The strong results that we continue to post have been a product of our sound strategic pillars based on customer centricity, productivity, and sustainability, which we deploy through six core priorities. Through these initiatives, we have been able to surpass all of our midterm targets, as shown on the right. In the next slide, we'll review the advances we have been making in digital transformation, productivity, and sustainability. Let me start with the analysis of digital transformation. Please move to the next slide, number 9. As part of our commitment to being the digital benchmark in the Chilean banking industry, we've implemented a range of initiatives this quarter for our personnel, corporate, and SME segments. In Personal Banking, we are proud to have successfully launched the digital onboarding platform for US dollar checking accounts, making it possible for customers to apply for credit cards online. Additionally, we introduced a new feature for over 8,000 customers who attended the Lollapalooza music festival in Chile, allowing them to top up credit for purchases at the event using our mobile app and avoiding long queues. For our corporate and SME segments, we also enabled 100% online account opening for US dollar checking accounts, providing greater convenience. Furthermore, we launched the online origination of the new Fogape government guarantee loans, called Para Apoyar, and introduced a virtual factory for prequalified prices, enabling them to manage their accounts receivables online. As a result, we're proud to be the leader among private banks in terms of total operations and total volume of loans granted to the Chile Para Apoyar program, granting over MXN270 billion to support SMEs. Lastly, we're pleased to mention that we now offer digital onboarding for a broad customer base from teenagers to adults and enterprises. These initiatives have streamlined the account opening process, reducing the time and effort required for customers to become our clients. We've attracted almost 1.2 million new clients through our digital accounts, increasing their customer base, transforming the banking experience, and promoting financial inclusion. Through these advances, we have placed Banco de Chile as the leader in different brand attributes in the digital world, as you can see on the bottom of the slide, when Banco de Chile customers are asked which are the best options for website security; we ranked first with a significant gap to our competitors. Please turn to Slide 10. To maintain our leadership in the industry, we have focused on establishing continuous processes to review and optimize costs and expenses. In the first quarter, we began executing our 2023 annual sourcing plan, which reviews a relevant set of cost categories to optimize both contracts and demand processes. This methodology involves gathering the market to identify new suppliers and innovations in goods and services, evaluating their fit and impact on our operations. By implementing this plan, we aim to achieve a cost optimization of approximately 10% of the total expenses addressed. Alongside our sourcing efforts, we are analyzing a set of opportunities for cost reduction that require specific views for analysis. One of them is the opportunity related to extending our footprint rationalization, as we have more information to understand customer behavior after the pandemic. Other key areas of analysis include IT investment processes where we will increase rationality in our decisions to allocate and prioritize funds and energy usage, where we seek not only to reduce expenses but also to boost our commitment to being a sustainable bank. We are also in the initial stages of renewing our ERP software system, a 12-month project aimed at advancing a 20-year-old system and enable faster and more automated procurement-to-pay processes. The new ERP will allow us to shift time spent on manual data entry activities into supplier billing, assurance, and control. Productivity is another key strategic pillar for us. We continue to seek to identify and implement measures that allow commercial staff to allocate more time to sales activities and increase use of digital channels for both sales and services. One of the most relevant levers for an increase in productivity has been digital process adoption by customers and employees, as well as the process improvement and standardization. In the retail banking segment, we have adopted our successful commercial excellence plan to other client segments, such as SMEs, to drive growth. In the SME segment, monthly originations have significantly improved the average loans per executive by 50%, and we are currently working to increase the number of customers with pre-approved loans to continue growing online originations. Our productivity projects, following the same principles of digital adoption and work standardization, will extend through the full year of 2023 and target the functions of deposits, cash management for SMEs, wholesale banking, and branch customer service. Thanks to a consistent improvement in product activity, Banco de Chile is one of the leaders in efficiency in the industry, achieving a 37.6% efficiency ratio during the first quarter. Please turn to Slide 11. During the first quarter, we continued to prioritize our commitment to contributing to the development of our country and its people through a variety of initiatives. Corporate volunteering is an important part of this effort, and we are proud to have supported people affected by forest fires, promoted accessibility at the Lollapalooza Music Festival, and worked with NGOs to assist elders. Our initiatives are designed to support those who are most in need while also promoting practices that benefit society as a whole. Additionally, we continue to offer support to clients affected by the devastating forest fire by providing options for rescheduling consumer and mortgage loans online and other branches. We have also committed to funding the reconstruction of a school in Santa Ana, which was destroyed by the wildfires, and to support the education of children in the affected communities. Supporting SMEs is a key priority in our ESG strategy, and during the quarter, we led a National Entrepreneurship Competition that brought together thousands of enterprises, and we also hosted an event for small Agro-ecological producers and sustainable businesses. We made strides in governance as well, increasing the diversity of our Board of Directors with the appointment of three women at our Annual Shareholders' Meeting. Finally, we provide a variety of training sessions on sustainable finance and the impact of climate change on the banking sector to our C-level executives, managers, and analysts. This training is part of our strategy to incorporate ESG risks and opportunities into our business model. Through our efforts to promote sustainable practices, both within and outside of our organization, we aim to create a positive impact in society and ensure long-term success for all of our stakeholders. Please turn to slide 13 to begin our discussion on our results. As previously mentioned, our net income has started to normalize in line with lower inflation, as shown on the chart to the left. In the first quarter, we reported net income of MXN266 billion, equivalent to a return on average equity of 21.6%, a significant decline from the high levels seen in the previous year. Despite this decrease, we continue to outperform our main peers in terms of profitability, as illustrated in the chart to the right. The solid financial performance is a testament to our successful long-term customer-centric strategy and our focus on creating a sustainable bank. While we expect our long-term ROE to be around 18%, we anticipate that ROE will remain above this range in the short term, hovering around 20% in 2023. This is due to the temporary boost in the net interest margin resulting from the high current levels of inflation and elevated short-term interest rates. Please turn to slide 14. Operating revenues grew 3% year-on-year and decreased 13% when compared to the fourth quarter of 2022. Both results are due to a sharp decrease in inflation, partially offset by steady expansion of customer income. On a year-on-year basis, we witnessed a strong rise in customer income as a result of stronger demand deposit contributions, given the scenario of high interest rates, moderate improvements in lending spreads and loan growth, and continuous increases in fee income. It's important to note that the 5% year-on-year growth figure in fees has to do with the change in accounting treatment of income from collection services for overdue loans, which are recognized in other operating income instead of fee income as used to be starting this quarter. Adjusting for this classification, fees would have grown 9% year-on-year. The annual increase is mainly driven by transactional services up 17% from credit cards and checking account commissions given higher transactionality, as well as an 18% rise in insurance brokerage in connection with a rise in written premiums in line with a more dynamic consumer loan portfolio. In terms of non-customer income, we generated lower revenues from our overall U.S. GAAP position because of a 105 basis point decrease in inflation during the period versus the same period last year, in conjunction with the decreased directional U.S. exposure managed by our treasury in relation to the same period last year. This effect, coupled with lower results from the management of our trading and investment portfolios, was primarily explained by the excellent performance achieved in the first quarter of last year when we benefited from the positive impact of interest rate movements on the financial positions held at that point. Instead, these factors to some extent were offset by greater net financial income from our securities brokerage subsidiary. The charts to the right show how our performance compares to our peers. In terms of NIM, we posted 4.5% this quarter, significantly higher than all of our competition. A similar situation occurred in terms of our overall operating income, as you can see on the chart on the bottom right of this slide. Our significant comparative performance responds to a consistent business strategy and our approach to timely managing risks, including market risk, all of which is supported by strong corporate governance standards. Please turn to slide 15. Banco de Chile is a universal bank that serves clients from all segments in retail and commercial banking. As you can see on the chart, we have 63% of our loans concentrated in the retail segment and the remaining 37% in the wholesale segment. This distribution has remained relatively stable compared to the fourth quarter of 2022. But it's important to highlight that during the pandemic, our growth was concentrated in low-risk, low-margin products, leading to a significant change in the loan mix. Nevertheless, we expect that our expansion in the coming period will begin to change the mix back to those levels we saw prior to the pandemic. It's also relevant to mention that our diversification is especially positive in different economic cycles, as one portfolio commonly offsets the negative performance of another. Consequently, total loans grew by 8.2% compared to the previous year and 0.9% when compared to the fourth quarter of 2022, as shown on the chart to the right. The year-on-year increase was driven by retail loans. Mortgage loans expanded 11% during the 12-month period, primarily fueled by inflation. In real terms, residential mortgage loans had a negative growth rate as a consequence of weaker demand due to high long-term interest rates and inflation perspectives. Consumer loan expansion, on the other hand, was driven by originations and posted a significant annual rise of almost 16%. This growth was in line with the lower liquidity levels of some customer segments. Originations were strengthened by successfully implementing campaigns to promote the use of credit cards and commercial strategies that have increased productivity and sales. Nevertheless, we expect consumer loan growth to slow to levels slightly above inflation by year-end due to the economic situation and customer debt levels. Commercial loans increased only 5.1% on a yearly basis, which was largely supported by an expansion in trade finance, influenced by both the normalization of international trade after the pandemic and renewed value offerings for factoring and leasing products among companies. Likewise, during the first quarter of 2023, we had a very active participation in the new Fogape Chile Apoya program, which aims to support SMEs and middle-market companies to access financing through government guarantees. As of March, we have originated approximately MXN 210 billion in loans, which also supported a modest increase in commercial loans. From a concentration perspective, it's worth noting that our commercial loan portfolio is well diversified across a wide array of economic sectors, as you can see on the chart on the bottom left. As such, we don't have any significant dependence or concentration risk in any industry, which enables us to mitigate potential effects derived from the economic contraction on real estate and construction or the ongoing situation affecting the private health industry. For 2023, we expect commercial loans to grow in line with inflation, with consumer and mortgage loans driving loan growth. We expect our commercial loans will continue to grow below inflation as long as economic and political uncertainties remain, and depending on the evolution of the economic downturn we are currently experiencing. Please turn to slide 16 to discuss our solid balance sheet structure. We have a diversified and healthy asset and liability structure, as you can see on the chart on the top left. Our business strategy is focused on commercial banking. Our main source of revenue is derived from loans, which represent 67% of our total assets as of March 2023. It's important to highlight that the total financial instruments of Banco de Chile represent 15.6% of total assets and our exposure to held-to-maturity financial instruments is particularly low, representing only 1.6% of total assets and well below the level of our peers, as you can see on the chart to the right. It's also relevant to note that 51.3% of our financial assets have durations of less than one year, explained by positions in Central Bank notes or DPBC and certificates of deposits issued by local banks, both utilized for liquidity management purposes. This structure has provided an important source of stability in our results, given its lower sensitivity to changes in market interest rates and, more importantly, based on adequate funding as we have seen in several parts of the world. In the cycles we are facing now, fundamental and prudential risk management criteria make a critical difference between banks. On the liability side, deposits are the main source of funding, representing approximately 51% of our assets. As for bonds, they represent 17% and are mainly used to finance our mortgage portfolio. This is especially important to reduce liquidity risk, as bonds are a more stable source of funding compared to time deposits. For that reason, during the first quarter, we continued to place bonds in the local market to replace scheduled amortizations while taking advantage of convenient market conditions. Also, our ratio of demand deposits to time deposits continues to move rapidly towards a more normal level, given the extraordinarily high levels of short-term interest rates implemented to control inflation and the normalized level of liquidity in the economy. Along these lines, we maintain a high level of liquidity compared to our main competitors and well above the limit imposed by the regulator, as shown on the chart on the bottom right. As for the liquidity coverage ratio, we recorded in the same period 183%, which is 183 percentage points above the limit. And in the case of the net stable funding ratio, we reached a level of 136% in March of 2023, six percentage points above the limit. It's also relevant to mention that we will continue to evaluate financing alternatives according to market dynamics, the evolution of demand deposits, time deposits, and loan growth. Please turn to slide 17. Banco de Chile is the most capitalized bank in the industry. As of March 2023, our Basel III ratio was 17%, well above the limit of 9.56% applicable to us, as shown in the table on the right. Regarding CET1, we reached 12.8% this quarter, 80 basis points lower than December 2022. This drop is mainly explained by dividend distribution that was higher than the dividend provisions in equity, as our shareholders decided to distribute 100% of the net distributable earnings for 2022 instead of the 60% already provisioned in equity. Nevertheless, the trend over the last few years has significantly surpassed both of our main competitors, as shown in the chart on the bottom left and is well above the limit established by the regulator. With these levels of capital, we are easily complying with fully loaded Basel III regulations. Finally, I want to highlight that the regulator has reassessed the systemic risk buffer for the banks, maintaining a ratio of 1.25%, as was the case for most of our peers. Please turn to slide 18. In the first quarter of this year, expected credit losses reached MXN106 billion, representing a 13.8% decrease compared to the fourth quarter of 2022, without establishing additional provisions. When compared to the same period last year, we see a slight increase of 7% as a result of the normalization of asset quality after a period of high liquidity that temporarily captured asset quality indicators unsustainably low. Consequently, as we anticipated in previous calls, delinquencies have been gradually increasing since the first quarter of 2022 from a very low level of 0.9% to 1.2% this quarter, as shown on the chart on the bottom left. This increment is a normalization to longer-term levels. It's also important to note that the trend for Banco de Chile has been lower than that recorded by our main competitors. When compared to our main competitors, as shown on the chart on the right, we not only have the soundest loan portfolio, but also the highest coverage ratio of 3.3 times, considering additional provisions of MXN700 million. This leaves us well positioned to face negative cycles. Lastly, we want to highlight the relevance and effectiveness of our risk management. As shown in the chart on the bottom right of the slide, we have continued showing the large gap with our competitors, ending the quarter with an operating margin net of risk of 5%, almost doubling their ratios. Please turn to slide 19. Expenses increased this quarter by 13% in nominal terms compared to the same period last year and decreased 1% in nominal terms compared to the fourth quarter of 2022. The annual increase is mainly due to the high inflation that reached 12% year-on-year, which has an impact on most expense concepts, including salaries, rent, and external services, among others. It's also important to mention that the significant advances in efficiencies that we have achieved in recent times have allowed us to support the significant growth, the disbursements defined to implement the advances in digitalization, IT infrastructure, and cybersecurity that are necessary to adjust to the profound transformation processes that the banking business is undergoing. Regarding the efficiency ratio, which is measured as operating expenses to operating income, we achieved 37.6% in the first quarter of 2023. When compared to our competitors, we continue to lead the gap in efficiency, as shown in the chart on the bottom right. We are confident that through our cost control strategy, increased productivity, and the use of technology, we will continue to post solid efficiency levels in the medium term. Please turn to slide 20. Before we move to the question-and-answer session, I would like to quickly summarize the key takeaways and provide some guidance. After a period of strong growth and record levels of inflation, the Chilean economy is gradually adjusting back to more normal levels of activity. We anticipate a mild recession until the second quarter of 2023, followed by a recovery in the second half of the year. Lower expected inflation levels should lead to an easing cycle midyear, with an overnight rate of around 7.5% and inflation at 5%. By 2024, we expect the monetary policy rate to reach 4.5% with inflation hovering around 3%. In this environment, we believe that our bank will continue to stand out from our peers. Our prudent and consistent strategy, together with our strong management team, has positioned us for another year of strong results and leading profitability while we can continue to pursue our long-term goals. Thank you for listening. And if you have any questions, we'd be happy to answer them.

Operator, Operator

Thank you very much for the presentation. We will now move to the Q&A portion of the call. Our first question comes from Mr. Juan Recalde from Scotiabank. Please go ahead, sir. Your line is open.

Juan Recalde, Analyst

Hi. First, congratulations on the strong results and thank you for taking my question. My question is related to the NIM. So I see that you increased the NIM guidance for 2023 to around 4.6%, which would imply an improvement versus the first quarter levels. So can you talk about what can drive the improvement in NIM? And second, looking into 2024, how much margin pressure do you think that we can expect? If you can comment on those two things, that would be great. Thank you.

Pablo Mejia, Head of Investor Relations

Can you hear me well? Yes, go ahead. Okay. So in terms of the margin, I think it's important to mention that we benefit from the rise in the interest rate estimations for this year. So the average monetary policy rate versus expectations earlier in the year is a little bit higher. So I think that's very important. We're expecting around 9.7% for this year versus what we were expecting earlier in the year, which was about 8% to 8.5%, relatively flat year-on-year. So our expectation today is a little bit higher average monetary policy rate, and that's a benefit. Also, the inflation is a little bit higher, around 5% for this year, which is also positively impacting us. That's one of the reasons why our expectations for the overnight rate has increased, and our NIM expectations have increased since the last call from 4.3% to 4.6%. In the medium term, we expect that things should return more or less to the same levels that we had prior to the pandemic considering a similar portfolio mix, which is very important.

Juan Recalde, Analyst

Okay. That's helpful. Thank you.

Operator, Operator

Thank you very much. Our next question comes from Mr. Andres Soto from Santander. Please go ahead, sir. Your line is open.

Andres Soto, Analyst

Good morning, Rodrigo, Pablo. Thank you for the presentation. I have two questions. The first one is related to expenses. You laid out a very interesting plan on how you can improve your efficiency over the medium term. I remember in the past, actually, from your last call, you said that your medium-term efficiency target was 45%, which I find actually quite high. Do you have any specific target for efficiency over the medium term based on the plan that you are presenting now? My numbers suggest that 40% is an attainable number. But I would like to confirm that?

Pablo Mejia, Head of Investor Relations

So through all the productivity improvements that we've been implementing, Banco de Chile has been controlling expenses. It's important to mention that the higher inflation has had a very important impact across all the line items for the bank. So salaries are indexed to inflation at least twice a year, and administrative expenses are also indexed twice a year; our administrative expenses are basically indexed to inflation. The results that we've had are quite positive; the 37.6% efficiency ratio, which is basically zero real expense growth. In the medium term, it will be very important to mention like the growth in terms of where we're going and how digital banking and the digitalization of Banco de Chile will continue being implemented within the bank. It's reasonable to expect that the target we showed on the slide in the presentation is to be below 45%. Levels close to 40% are reasonable, depending on competition, obviously, and the implementation of all these digital initiatives, which will continue streamlining processes, automating back-office processes, and improving the bank's overall operations.

Andres Soto, Analyst

Thank you, Pablo. My second question is regarding the additional provisions that you guys still have on the balance sheet. As you presented, this is much higher than any other bank in Chile, and this even considering that Banco de Chile is having better asset quality trends compared to most of your peers. You have almost $900 million in these additional provisions, so my question is, what are your thoughts around it? Is it possible that you guys consider distributing this as an extraordinary dividend to shareholders?

Rodrigo Aravena, Chief Economist and Institutional Relations Officer

This is Rodrigo Aravena. Thank you for your question. It’s crucial to understand that additional provisions are influenced by the state of the economy, particularly the unemployment rate and various uncertainties. We still face significant uncertainties in the Chilean economy, such as the ongoing process of drafting a new constitution. This weekend, elections will be held for the members of the new constitutional assembly, and there will be another referendum by the end of the year. Additionally, the government has expressed intentions to initiate discussions on tax reform after the elections. Consequently, we will encounter considerable uncertainties this year, and we cannot dismiss the possibility of a further economic slowdown in the short term. This is why we cannot rule out the need for new provisions. However, it’s important to note that we are comfortable with our current level of additional provisions. Our core ratio is the highest in the industry, which is also a significant point. To better assess the timing for releasing additional provisions, we need more clarity on key uncertainties, including the political landscape and employment in Chile. Ultimately, while discussing potential timelines for the release of additional provisions, it is essential to emphasize that we currently hold the highest ratio in the industry and feel secure in our present level.

Andres Soto, Analyst

Understood. Thank you very much, Rodrigo.

Operator, Operator

Thank you very much. Our next question comes from Mr. Ernesto Gabilondo from Bank of America.

Ernesto Gabilondo, Analyst

Thank you. Hi, good morning, Rodrigo and Carlo. Thanks for the opportunity to ask questions. The first one is a follow-up on NIMs. So before you were guiding a NIM pressure of 120 basis points, but now it seems to be only 90 basis points. But again, now to the first question, can you repeat how much could be the pressure next year? And then my second question is a follow-up on this research coverage ratio. As you pointed out, you have excess provisions of MXN 700 million for any potential uncertainty. But what is your historical research coverage ratio talking about pre-pandemic levels, and considering that you're going more into a riskier loan mix into retail, what would be the new normalized end of research coverage ratio? And then my last question is on your effective tax rate. It has been down because of the inflation, but now considering that at some point inflation will start to go down? And how should we think about the effective tax rate over the next years? Thank you.

Pablo Mejia, Head of Investor Relations

Thanks, Ernesto. So for NIM, as I mentioned, the overnight rate has a very important effect, and also inflation. The sensitivity for Banco de Chile is something very near around 14 to 15 basis points of NIM for every 100 basis points change in inflation in the overnight rate; after everything re-prices over three years, it's around 30 basis points. For 2024, we expect periods of normalization from the very high levels that we had in 2022. So for this year, we're expecting, because of the higher overnight rate, slightly stronger expectations for 2023 than we had earlier in the year. For 2024, this should continue to decline slightly until we normalize the portfolio. It's important to mention that we are not really entering more risky loans. If we look at where we were in the past and where we are today, we have a portfolio that's grown mainly during the pandemic in low-risk, low-margin products. The mix in the portfolio is much less risky than it was prior to the pandemic. What we're saying is that in the medium term, we should return to a similar level that we had prior to the pandemic in terms of mix and risk levels. A reasonable level of risk for us of NPLs (non-performing loans) and the cost of risk is around 1.1% to 1.2%. If we look at where we are today, we are near that level in the NPLs. But in the impaired loan portfolio, we're still below that level. Why? Because customers have had high liquidity over the years, and there's very little renegotiations versus the path of impaired loan portfolio being less affected than in the past. We still have room to continue normalizing. In the future, the coverage ratio of the NPLs should be something similar. Reasonable to expect that most banks should return to levels similar to what they had prior to the pandemic. It's a reasonable assumption. Now as Rodrigo mentioned, the exact timing to reverse these provisions is something that's not set as of yet. And in terms of the effective tax rate, the effective tax rate is affected by the price level restatement in Chile. The tax authorities use inflation accounting to calculate net taxable income for banks. So there's an important effect of inflation that affects that income before taxes. As inflation is higher, you have higher costs due to price level restatements, and as inflation decreases, that cost decreases as well. It is reasonable to expect the effective tax rate to normalize similar to what we've had in prior years with normalized levels of inflation around 23%.

Ernesto Gabilondo, Analyst

Excellent. Thank you very much, Pablo.

Operator, Operator

Thank you very much. The next question is from Ms. Neha Agarwala from HSBC Global Research. Please go ahead, Ma'am. Your line is open.

Neha Agarwala, Analyst

Thank you so much. A quick question on what is a normalized level of NIM that we should expect, say, by 2025? Would it be around 3.5% to 3.7%? Is that a good range? And my second question is what kind of ROE should we expect for this year closer to 20% or maybe slightly lower than that for 2023. Thank you so much.

Pablo Mejia, Head of Investor Relations

Hi Neha. So for NIM, a normalized level of NIM should be, as I mentioned, around the levels that we had pre-pandemic, which is the 4.5% level, around that level. So why around that level? Well, and why we're at this level today is because of what I mentioned is the loan mix, and there are still many impacts that have occurred during the pandemic that have adjusted the level of revenues for banks—this should continue to normalize in the medium term as we return to those segments that we weren't in the past. We have the Fogape loans, which are very low-interest rates. We have different products, which are lower margin, lower risk, which should normalize. If we look at where we will be in 2025 or 2024, we will probably have higher overnight rates than we had in the past. This is also positive. In terms of ROE for this year, what we've mentioned is that the expectation for ROE is around 20%. In the medium-term, we think around 18% is reasonable considering the levels of capital and the levels of competition existing.

Neha Agarwala, Analyst

Thank you very much.

Pablo Mejia, Head of Investor Relations

Thank you for listening. And we look forward to speaking with you for our next quarter results. Bye.

Operator, Operator

This concludes today's conference call. We'll now be closing all lines. Thank you very much. Goodbye. Have a good weekend.