Earnings Call Transcript
BANK OF CHILE (BCH)
Earnings Call Transcript - BCH Q4 2024
Operator, Operator
Good afternoon, everyone, and welcome to Banco de Chile's Fourth Quarter 2024 Results Conference Call. If you need a copy of the management financial review, it is available on the company's website. With us today, we have Mr. Rodrigo Aravena, Chief Economist and Institutional Relations Officer; Mr. Pablo Mejia, Head of Investor Relations; and Daniel Galarce, Head of Financial Controller Capital. Before we begin, I would like to remind you that this call is being recorded, and 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. Thank you for joining this conference call. Today, we will discuss Banco de Chile's overall performance during the fourth quarter and for the full year 2024. We are proud of our performance over the last year. The strong financial results and significant progress in several key areas reaffirm the leadership that our bank has maintained over time. In 2024, we were able to outperform our primary competitors in many areas. Financially, we led the banking industry with a net income of CLP 1,207 billion, resulting in a return on average capital of 23.1%, significantly higher than the 15.8% average in the local industry. This exceptional result was driven by positive figures for margins, asset quality, and efficiency. We also achieved important results in various non-financial aspects, including advancements in retail banking and the creation of a new subsidiary to compete in the acquiring business, while maintaining our leading position in areas critical to our strategy, such as service quality and motor funds. Our positive performance has been acknowledged by several institutions. In this presentation, we will provide a detailed analysis of our bank's performance over the last quarter and the full year. First, I would like to share a brief overview of the macroeconomic environment. The Chilean economy continues to show improvement, with a 2.5% expansion in 2024, compared to only a 0.2% growth last year. This uptick can be attributed to a sequential improvement in activity, with GDP growth rising from 2% year-on-year in the first half to 3% in the second half. Contributing factors include a gradual normalization in deflation and a significant reduction in interest rates. The acceleration in commerce, reflecting improving domestic demand, was notable, with commerce activity rising by 7.4% year-on-year in the fourth quarter, achieving its highest growth in almost three years. Commerce expanded by 3.8% in 2024, in contrast to a 3.5% contraction in 2023. Mining also recovered, growing by 7.5% year-on-year in the fourth quarter and 6.2% for the year. The service sector has seen stable growth due to previous improvements. The slight recovery is evident in the labor market as well, with an 8.1% employment rate in the fourth quarter, down 40 basis points from last year, fueled by a 2.9% year-on-year increase in total employment. The labor force rose by 3.5%, driven primarily by wage workers, who increased by 2.7% year-on-year in this quarter. Consequently, the unemployment rate fell from an average of 8.6% in 2023 to 8.5% in 2024. Now, let’s examine the evolution of price rates and their impact on the overall economy. We have observed a higher-than-expected persistence in the overall Consumer Price Index. In December 2024, CPI had a 12-month increase of 4.5%, exceeding prior expectations due to two main factors: rising electricity bills, which are expected to impact inflation by nearly 150 basis points, and the unexpected weakness of the Chilean peso, which is critical in a country where over half of the CPI basket is made up of tradable goods. The Central Bank acknowledged the potential for other inflation risks and decided to maintain the interest rate at 5% during its last policy meeting in January. However, it is important to note that the Board reduced the rate by 625 basis points between July 2023 and December 2024, making the Central Bank of Chile one of the most proactive globally in lowering reference interest rates. The peso significantly weakened in 2024, averaging CLP 944 per dollar, a 13% increase compared to 2023, marking the weakest figure in history. This depreciation has been attributed not only to the easing of local monetary policy but also to the strong global USD. Despite this context, the weaker peso positively influenced the external account, allowing the trade balance to achieve a historical surplus of $22 billion, aiding in reducing the current account deficit. Now, I will share our base scenario for this year. We expect the economy to grow by 2% this year, driven by positive dynamics in exports, influenced by the weak exchange rate and persistently high copper prices. However, we recognize some negative factors affecting our GDP forecast, such as import tariffs from the U.S. and other countries. We anticipate an improvement in domestic demand due to a slight uptick in investments, driven by more optimistic expectations and lower interest rates. After a temporary spike in inflation, we foresee normalization throughout the year, based on three main factors: the absence of adjustments in regulated prices comparable to last year's electricity bill increases, expected appreciation of the peso contributing to reduced inflation pressures, and decreased inflationary pressures from slightly lower GDP growth. Nonetheless, these factors may not suffice to bring CPI variations back to the 3% target midpoint this year. Overall, we expect inflation to be around 3.8%, with a bias towards higher rates. In this environment, we do not anticipate changes to the reference interest rate in the first half of this year, with a potential reduction towards 4.5% by year-end, contingent on inflation expectations dropping to 3% within the two-year policy timeline. As in past webcasts, these forecasts carry certain risks. The global environment significantly impacts Chile due to its integration with the world, and key factors to monitor include GDP trends in China and the U.S., geopolitical dynamics, and new policies from authorities in the U.S., especially regarding tariffs and migration. Additionally, it’s crucial to observe inflation trends and leading indicators of gross investment, vital for loan growth. Finally, we must pay attention to the political landscape, given this year’s presidential and congressional elections. Before we discuss the bank’s specifics, I will briefly cover the main trends in the banking industry. Despite the sluggish economy, banking profitability remains robust, with a return on average capital of 15.4% this quarter, slightly down from prior quarters. This profitability can be attributed to several factors, including efficient cost management, income diversification, and strong risk mitigation strategies. Financial institutions have maintained their performance amidst global challenges, showcasing resilience and adaptability. Technological and digital innovation further enhance operations, reduce costs, and improve customer experience, positively impacting financial performance. Business volumes saw modest loan growth for the industry in 2024, with a total nominal expansion rate of 4% year-on-year. Mortgages drove this growth, rising by 6.2% year-on-year, whereas consumer loans increased by 4.6%. Conversely, commercial loans have seen slower growth, at only 2.4% year-on-year. The ongoing weak growth in commercial loans has caused a notable shift in the loan portfolio mix compared to pre-pandemic levels. Currently, mortgages account for 35% of total loans, up from 29% in 2019, while commercial loans have decreased from 56% to 52%, and consumer loans fell from 15% to 12%. If we exclude the effects of higher inflation and interest rates, net interest margins would be lower than they were in 2019, assuming all else equal. Now, Pablo will provide more details about Banco de Chile's progress and financial performance.
Pablo Mejia, Head of Investor Relations
Thank you, Rodrigo. Let's start with an overview of our strategic progress. Please go to Slide number 9. We are successfully executing our strategy that focuses on customer satisfaction, efficiency, and sustainability. Our advances are driven by six main priorities shown at the center of the slide and on the right are our midterm targets. Our main priority in this regard is to be not only the most profitable but also the most sustainable bank among our peers. As such, we are aspiring for a long-term return on average capital of around 18%, assuming positively sloped yield curves and inflation returning to the Central Bank target. If yield curves begin to steepen, and inflation remains above neutral levels in the short run, and we recover our pre-pandemic mix of loans, this level could possibly be higher. In line with this, our cost-to-income performance in recent periods has consistently surpassed our long-term targets. For 2024, in particular, this has been attributable to strong top-line growth resulting from increased customer revenue and temporary extraordinary effects post-pandemic, as well as effective cost control initiatives. We are confident that our long-term productivity levels will continue to improve through ongoing and forthcoming operating improvements, which we'll discuss later in the presentation. In terms of market share, our aspiration is to be a leading bank in commercial and consumer loans as well as demand deposits in local currency. Throughout the year, we have increased our market share in high-margin lending products, such as consumer installment loans, by maintaining an appropriate risk-return balance based on responsible credit risk management practices. Additionally, we have regained leadership in local currency demand deposits, a traditional competitive advantage that has provided us with both competitive funding and a stable source of funds. We are also dedicated to providing a high-quality customer experience and contributing positively to society. The result of this is reflected in a remarkable Net Promoter Score and corporate reputation ranking where we're positioned in second place. We have achieved this by actively investing in resources and comprehensive training programs for our employees to ensure they deliver exceptional service, continuously reviewing customer satisfaction levels, making relevant adjustments to improve contact channels, processes, and product offerings, and actively engaging with the community in diverse areas such as volunteering, education, entrepreneurship, among others. In the next slide number 10, we'll cover the highlights of our advances in digital banking, efficiency, and ESG. In terms of digital banking, we are pleased to report continued growth in our main digital account fund, achieving 1.7 million customers last year. We have further expanded our customer base with the introduction of new digital accounts such as Panoro and the current account for university students. We have also enhanced our main banking application by adding new features to ensure a seamless experience for our customers. A key milestone was the integration of the insurance platform, allowing customers to manage their policies directly within the app instead of using a separate application. For companies, we remain committed to innovation, delivering enhanced financial solutions. In 2024, we launched many initiatives, including Pagoplassi, a tool designed to simplify mass payment services for customers and streamline their financial operations. Additionally, we announced a new subsidiary focused on expanding our role in payment processing, which will provide businesses, especially SMEs and middle-market clients, with a flexible and efficient payment solution. On the efficiency and productivity front, we continued implementing diverse initiatives to position ourselves as a fast, secure, and fully digital bank. As part of our optimization plan, we have digitalized our branch sales and service processes, creating a more seamless customer experience that encourages greater adoption of online channels. These enhancements have allowed us to reduce our branch network by 12% year-on-year, and our headcount declined 5% year-on-year, reflecting our commitment to efficiency, while providing customers with the tools and incentives to manage their banking needs digitally. On another front, we have worked closely with our subsidiaries to generate corporate-level synergies, optimizing resource allocation and space usage. Additionally, we are optimizing technology-related expenses by renegotiating key contracts, consolidating IT and some back-office processes, and enhancing cloud and data center infrastructure. In marketing, we have prioritized digital strategies, reducing traditional marketing costs and optimizing loyalty program expenses. Importantly, all these initiatives have been accompanied by high customer satisfaction and an outstanding organizational climate, reinforcing our strong relationship with our clients and employees. Our commitment to becoming a more efficient bank has been driven by significant advances, including expenses growing below inflation while maintaining a solid cost-to-income ratio. While there is still room for improvement, we are confident in our ability to achieve even better long-term goals. Finally, in 2024, we remain committed to being a sustainable and responsible bank. At Banco de Chile, we recognize that entrepreneurs are a key force for the development of the country, which is why we actively support them through diverse programs. For example, we lead the market in financing SMEs through the FOGAPE Chile Apoya program. Additionally, we organized various contests such as the entrepreneurial challenge and women who inspire, fostering innovation and inclusion in the business landscape. Last year, we also continued boosting our volunteering program, covering areas such as financial education, technical professional education, entrepreneurship, environmental care, and inclusion. And finally, for the 11th year in a row, we were named the best company for attracting and retaining talent in Chile, demonstrating our positive impact on the community and our employees. Please turn to slide 12, so we can begin discussing the key highlights of our financial results for the quarter and the full year. We have once again demonstrated our capabilities of achieving strong quarterly and annual results despite the challenging environment, sustaining our track record of success. Our net income for the quarter reached CLP 298 billion, representing an increase of 3.5% compared to the previous quarter. For the full year, our results amounted to CLP 1.2 trillion with a return on average capital of 23.1%. Furthermore, when comparing our results with those of our peers, we consistently achieved superior performance across all metrics throughout the year. As illustrated in the accompanying charts, we not only maintained a significant year-to-date lead in net income, but also continue to deliver an exceptional return on average assets that almost doubles our closest competitor. These achievements underscore our competitive edge in the market, demonstrating our sustained leadership in the sector and the effective implementation of our strategic initiatives. Please turn to slide 13. Regarding operating revenues, we posted a 10% decline in quarter-on-quarter growth and an annual increase of 1.9% in full-year figures. This performance was driven by steady growth in customer income, which showed a quarterly rise of 3% and an annual increase of 9%, given the recovery in certain commercial products. Nevertheless, this was counterbalanced by a quarterly reduction of 38% and an annual decrease of 19% in non-customer income. This decline was primarily attributable to the maturity of the FCIC program across the industry, which has provided a low-cost funding source, and also the effect of lower inflation on our revenues. It's important to note that the main drivers of expanded customer income on a yearly basis were income from loans, up CLP 107 billion, higher contributions from both demand deposits and time deposits growing CLP 70 billion, and fees rising CLP 26 billion in 2024 when compared to 2023. The core of our commercial strategy is long-term sustainability. This means avoiding unnecessary short-term risk and focusing on long-term growth by managing all business units responsibly. This emphasis has gradually allowed us to increase average spreads and expand loan volumes in target segments and products. Consequently, the growth in income from loans was largely due to consumer loans and, to a lesser degree, residential mortgages. The consumer loan book balances and spreads grew 4.6% and 164 basis points, accounting for over 90% of the total rise in loan income. Mortgage loans also contributed significantly with an average balance increasing by 7.4% year-on-year. In contrast, commercial loans rose by only 0.6%, with SME segments growing 2.6%, while wholesale business remains flat, reflecting the different dynamics affecting the banking segment. In terms of funding, we benefited from a higher contribution from total deposits, driven by a 6.8% expansion in DDA average volumes, particularly over the second half of the year and improved margins on time deposits. The expansion in time deposit contributions has primarily been the result of proactive and targeted pricing strategies deployed across all business segments. Finally, the yearly 4.8% increase in net fees was concentrated in three income streams. First, revenues from mutual and investment fund management grew by 20% year-on-year. This was driven by a significant expansion in assets under management that rose 38% year-on-year on the grounds of the launch of a new series of funds offered to our customers. Second, fees from credit and contingent loans rose 20% year-on-year. This was supported by both greater fees from layers of credit and guarantees, and collaterals, which align with the positive trend posted by trade finance loans, and the annual increase in loan prepayments, primarily attributable to greater prepayments in consumer loans, and to a lesser degree, by commercial loans due to some wholesale banking operations that were repaid in advance or restructured, all in line with the reduction of interest rates throughout the year. Finally, cash management services and wire transfer payments orders rose CLP 11 billion due to the renegotiated interbank clearance fees and greater transactions and foreign currency payment orders requested by our customers. The charts on the right show how we perform compared to our competitors. We continued our trend of outpacing our peers in all the main profitability ratios. The net interest margin stood at 4.9% for the year, while the fees margin and operating margin posted solid levels of 1.2% and 6.6%, respectively. This positive performance stems from the successful implementation of our business strategy and the dedication to providing an enhanced value proposition to customers through both the lending and non-lending products and services by leveraging both our banking capabilities and specialized services provided by subsidiaries. Please turn to Slide 14. The breakdown of our loan portfolio is distributed across different business segments providing stability and revenue-generating capacity. Currently, our retail loan portfolio represents 65% of the total loan book, while wholesale commercial loans account for 35% of the overall loan portfolio. Additionally, as illustrated in the chart on the bottom right, commercial loans are well diversified across different economic sectors. This distribution is important because during economic cycles, like the ones we have been experiencing in recent years, one sector can outperform another, helping to support our bottom line on average while avoiding volatility. The sluggish performance of local activity during the last years has impacted loan growth across the industry. A lack of private investment, coupled with low business and consumer confidence, has hindered growth. Consequently, total loans grew moderately in nominal terms of 3.4% and decreased 1% in real terms. As mentioned earlier, the main drivers of this growth came from the retail segment as illustrated in the chart on the bottom left. Instead, the Wholesale Banking segment was affected by the market dynamics that led to subdued demand for loans from both corporations and SMEs. For 2025, we anticipate a reversal of this trend, with commercial loans gaining momentum versus the low expansion in 2024, primarily driven by lower inflation, reduced political and economic uncertainties, and lower short-term interest rates. These factors should also enhance dynamism in retail products. As a result, we expect the industry to grow by approximately 4.5% in nominal terms with Banco de Chile outperforming this, particularly in our target segments. Please move to slide 15 to review the structure of our balance sheet. As shown on this slide, our balance sheet is returning to the structure of assets and liabilities that we had before the pandemic. On the asset side, government-backed low-interest loans extended to SMEs during the pandemic have predominately matured. Additionally, the ratio of total loans to total assets has returned to levels of almost 75%, consistent with the important reduction in financial securities that were utilized to fully repay the Central Bank's FCIC in April and July of 2024. As shown on the chart on the top left, the effect of FCIC repayment is evident in all the asset line items associated with fixed income securities and loans and advances to banks, which include overnight deposits in the Central Bank. The table on the bottom left indicates that despite repaying this large debt to the Central Bank, primarily with financial instruments, liquidity levels have remained strong and well above the regulatory requirements. As of December 2024, the liquidity coverage ratio was 214%, exceeding the regulatory minimum by 114 percentage points, while the net stable funding ratio was 120%, surpassing the required level by 40 percentage points. It's also worth discussing the evolution of our deposits, as shown in the chart on the top right and in the table in the middle of this slide. Demand deposits have returned to pre-pandemic trends by currently representing nearly half of total deposits and 31% of total liabilities, which is slightly above our historical average and well above the industry average. On the other hand, we observed an 8% year-on-year decrease in customer time deposits, well-aligned with the Chilean Central Bank rate cut from 8.25% to 5% in 2024, together with inflation rates that have remained above the Central Bank target rates, reducing the real profitability of these savings instruments. Consequently, customers are looking for investments with higher returns. This is one of the key factors behind our strong results in mutual fund management, which saw nearly 40% year-on-year growth in AUM. Before moving to the next slide, I want to share our US GAAP progression as shown on the bottom right, reflecting our proactive asset and liability management. Effective management over recent years has allowed us to capitalize on short-term inflation fluctuations, as well as to protect our shareholders' equity and real value in the long run. As of December 2024, our position is CLP 9 trillion, meaning that a 1% change in inflation generates a sensitivity and income of approximately CLP 90 billion. Please turn to Slide 16. From the capital adequacy perspective, we maintain a leading position in capitalization among our peers. As depicted in the chart on the left, our CET1 ratio attained 14.4% in December 2024, consistently exceeding that of our peers while remaining well above the regulatory threshold. A similar trend can be seen in our total capital adequacy ratio, as depicted in the chart located on the bottom left. These levels allow us to be well-prepared for both the final stages of Basel III implementation and the expected recovery in the banking business that should translate into balance sheet growth in the medium term. Along these lines, the CMF has proposed modifications to the current Basel III regulations in Chile, focusing on changes related to capital requirements considering Pillar 2 risks, particularly associated with interest rate risk in the banking book, IRRBB and the definition of outlier banks. The proposed ruling was available for public comment until November 8th, 2024, and the final set of roles has not yet been published. However, it's important to note that in January 2025, under the current standard, the CMF reduced our Pillar 2 charge from 0.5% to 0.13%. This reduction was possible due to the important decrease we recorded in the current long-term IRRBB metric, or Delta EVA. It's important to note that this does not account for changes proposed by the CMF regarding Pillar 2, which should be announced in the near future. Please turn to Slide number 17. The expected credit losses reached CLP 103 billion in the fourth quarter of 2024, down 19% from a year earlier. The reduction is due to higher-than-normal provision expenses in the fourth quarter of 2023 due to two factors. First, the adjustments in provision models in December 2023 focused on personal banking and second, a temporary rise in 30-day NPLs during that period. On a yearly basis, expected credit losses posted an 8.4% increase, equal to CLP 31 billion. This led to a slight increase in our cost of risk ratio from a low level of 0.98% in 2023 to a still low level of 1.03% in 2024. The rise was a result of opposite forces. First, wholesale banking's annual expected credit losses expanded CLP 36 billion in 2024, supported by a lower-than-normal comparison base in the prior period and a deterioration in the risk profile of certain customers belonging to the real estate and transportation industries in 2024. On the other hand, the cost of risk in the Retail Banking segment declined to CLP 25 billion compared to 2023. This decrease was mainly related to the previously mentioned revised parameters for provisioning models in 2023, together with stabilized NPLs during 2024 after a period of steady growth in 2023. As of December 2024, our total NPLs decreased from the third quarter of 2024 from 1.5% to 1.4%, as illustrated in the top right chart, and we have performed exceptionally well when compared to our peers. The delinquency ratio in consumer loans has returned to the pre-pandemic levels of 1.9%, as indicated in the chart on the bottom right. We have also observed a slight uptick in mortgage loans during this period, which aligns with broader industry trends and the weak economy. NPLs for commercial loans have decreased to 1.4% from the 1.5% posted a year earlier. We expect NPLs to continue stabilizing and to begin to show signs of improvement as the economy gradually recovers in coming quarters. As shown on the chart on the bottom left, our loan portfolio has the highest quality with a coverage ratio of 265%, supported by additional provisions totaling CLP 700 billion as of December 2024, which are by far above those of our peers. This position allows us to manage potential risk deterioration or face regulatory changes in risk provisioning models such as the new CMF standard model for consumer loan provisioning, which took effect in January 2025 and resulted in a one-time impact of CLP 69 billion. As we report in 2024, we used our additional provisions to address the impact of this model. Please turn to Slide 18. Regarding operating expenses, our cost base totaled CLP 303 billion in the fourth quarter of 2024, down 4.9% from the level posted in the fourth quarter of 2023. The reduction was a result of strict cost control measures implemented throughout 2024, which coupled with a high comparison base in the fourth quarter of 2023 due to one-time expenses incurred due to the renegotiation of collective bargaining agreements with our staff. This was partially offset by an annual increase in severance payments in the fourth quarter of 2024 related to organizational restructuring. On a yearly basis, operating expenses amounted to CLP 1.2 trillion in 2024, which is only 1.5% above the figure posted in 2023 and well below the inflation rate of the period of 4.4%. The slight nominal growth was mainly driven by higher administrative expenses, as shown in the chart at the top right. This was mainly the result of IT-related costs related to the updates of software licenses, support services, and cloud usage expenses that stem from internal developments aimed at supporting our digital channels. This was also partially mitigated by a CLP 5.7 billion reduction in advertising and marketing expenses, along with various other cost items compared to the previous year, which aligned with our cost control initiatives that pursue to improve productivity across all operational and administrative processes. In terms of efficiency, we recorded a ratio of 39% for the quarter and 37% for the year, better than our peers, as shown in the chart on the bottom of this slide. We are confident that the progress we have made in efficiency and productivity will help us ensure that our long-term efficiency levels continue to be below 42% in the long term and around 40% in 2025. Please turn to Slide 19. Before moving on to questions, I want to highlight key points from this presentation. We expect a 2% GDP growth in 2025 with a recovery in domestic demand. Inflation and interest rates are expected to remain above their long-term levels. Given the economic factors, we are confident that our long-term strategy and our strong risk culture will keep us leading in profitability and asset quality. We aim for a sustainable long-term return on average capital of around 18%, potentially higher if market conditions like inflation and overnight rates stay high. We hold the strongest capital base among peers, which makes us well-equipped to seize emerging business opportunities and drive future growth. Finally, we continue to consistently outperform our peers in profitability and net income with lower levels of risk, as shown in the chart to the left. Thank you for listening. We're happy to answer any questions you may have.
Operator, Operator
Thank you very much for the presentation. We’ll now be moving to the Q&A part of the call. Our first question comes from Mr. Ernesto Gabilondo from Bank of America. Please go ahead, sir. Your line is open. Hi, Ernesto, just in case you are muted, please note that your line is open now.
Ernesto Gabilondo, Analyst
Can you hear me now?
Operator, Operator
Yes, we can hear you now. Please go ahead.
Ernesto Gabilondo, Analyst
Sorry. Thank you. Hi, good morning, Rodrigo, Pablo, and Daniel. Thanks for the opportunity to ask questions. My first question will be on the political side. Chile has interim elections last year, I believe, presidential polls are pointing for center-right candidates. So whom does management believe could be the leading potential candidates? I'm seeing Matthew, Kaiser, or Bachelet. Can you give us some color on the background of these candidates? And what are the chances of having them in the last round? And considering this scenario, how should we think about Congress? Should it be with a divided majority? What should be your best-case scenario? And what do you think are the two key reforms that Chile needs to return to its growth potential? So that that will be my first question. And for my second question is on your non-interest income growth expectations for this year given that fees could experience another cap on the merchandise discount rate, how should we think for the non-interest income growth in 2025? Thank you.
Pablo Mejia, Head of Investor Relations
Thank you, Ernesto. Rodrigo, we'll go ahead. This is Pablo Mejia here with the first part of your question.
Rodrigo Aravena, Chief Economist and Institutional Relations Officer
Hi, Ernesto, this is Rodrigo Aravena. Thank you very much for the question. I'm going to take the question related to the political environment and the challenge that we have in Chile. First of all, I think it's very important to mention that the elections will be held by November of this year. However, we don't have final candidates yet. So it's very complicated to have a more accurate estimate in terms of the final results for coalitions, etc. However, I think it's very important as well to mention that the main balance for the Chilean economy towards the future is to increase the capacity of growth. During the last year, the average growth in Chile has been around 2%, which is consistent with our potential capacity of growth according to the Central Bank and the Finance Ministry as well. So I think that it's reasonable to expect an overall growth of around 2% for at least for the next two years. It is also important to be aware of several high risks from the rest of the world. Today, what we've seen is an important increase in geopolitical risk in different countries in the world and also more pressures from global inflation and higher interest rates, etc. However, it's also worth mentioning that Chile has very strong fundamentals to face a more challenging environment. For example, Chile remains as a country with the best sovereign rating in Latin America. And also, we have a strong political system supported by checks and balances and very strong institutions as well. That's why we remain very confident about Chile's ability to be the best country in terms of risk level and capacity to achieve more stable growth in the future. With respect to your question about the factors that would increase the capacity to grow in Chile, I think that there are different casual factors related to initiatives that tackle bureaucracy in the new investment projects in Chile. It's also important to mention that the country was able to approve a new pension reform that would be positive in terms of rising internal savings to provide more liquidity and business to the capital market as well. So all in all, we remain confident about both the country and the financial system and the banking system to face the different challenges because, at the end of the day, we've seen important long-term fundamentals in the country beyond the short-term political cycle.
Pablo Mejia, Head of Investor Relations
In terms of fees, it's important to highlight that customer growth is a key driver of fee growth for Banco de Chile. A significant proportion of fees comes from retail customers, which remains stable. Over the past years, Banco de Chile has seen a mid-single-digit growth, about 6% in retail current accounts, which is the main factor in this growth. Looking ahead to 2025 and beyond, customer growth will be a critical component in evaluating our overall growth, with expectations in the mid- to high-single-digit range. Currently, we observe strong growth in mutual fund management as interest rates have decreased, prompting customers to seek more appealing rates for their deposits. This shift has resulted in a transition from time deposits to significant growth in mutual funds. Current accounts and credit cards also play a vital role in this growth. Regarding the postponed merchant fee discount, there were three planned reductions for February 2023, October 2023, and now October 2024, which has been put on hold. Therefore, the current rates effective as of October 2023 remain unchanged at 0.5% for debit cards, 1.14% for credit cards, and 0.94% for prepaid cards. There are no updates on potential changes in the near future, and this will be an important factor to monitor. I hope that addresses your question.
Ernesto Gabilondo, Analyst
Yes. Thank you very much, Rodrigo and Pablo. Just a follow-up on the political question. So you were mentioning that it will be key to reduce bureaucracy in Chile to probably have a much higher potential economic growth, but as a base case scenario, you continue to see around 2% GDP growth over the next years. And then I don't know if you mentioned a little bit about the color on Congress. How can we expect Congress to support these structural reforms? Could it have a majority or is it still too soon to tell? Or do you think it could be divided given that maybe the left wing still has a lot of votes?
Rodrigo Aravena, Chief Economist and Institutional Relations Officer
There is a general agreement in Chile regarding the need to enhance future investment. Analyzing the potential GDP growth in Chile reveals that the labor force has contributed more to potential growth than capital has. Unfortunately, we have not made significant progress in terms of overall productivity. This has led to discussions in Chile about various proposals, referred to as Permisologia, which seek to evaluate different rates to streamline environmental licenses and approvals. We need a nationwide agreement with political backing, although this will likely be addressed by the next government. In Chile, there are various coalitions and parties, but the presence of significant checks from Congress on the current administration is a positive sign for the long term, as it highlights the necessity for consensus and a long-term perspective, akin to what we witnessed in the previous government. We believe that the conditions are in place to enhance productivity moving forward; this will be the key challenge for the next administration. However, we lack specific information on the final presidential candidates, and it remains uncertain how the coalition between left and right parties will form. We will likely have more clarity in the next quarter. Given the present fundamentals, it is reasonable to anticipate a growth rate between 2% and 2.5%. This could improve in the future if we address the underlying issues in Chile, but again, this will likely be a topic for the next government.
Ernesto Gabilondo, Analyst
Terrific. Thank you very much, Rodrigo.
Operator, Operator
Thank you very much. Our next question comes from Tito Labarta from Goldman Sachs. Please go ahead, sir. Your line is open.
Tito Labarta, Analyst
Hi Pablo, Rodrigo, thanks for the call and taking my question. My question is on your ROE guidance of 18%. Do you expect to reach your sustainable level this year? I know you expect lower inflation. But just to understand, it seems a little conservative. I mean, for us to get to that number, you'd probably have to be at the low end of your margin guidance and at the high end of your cost of risk guidance. Is that sort of how we should think about it? And I ask you mentioned that one of your goals is to be the most profitable bank in Chile. Your main peer is guiding for ROE above 20%. And I know this difference from a capital perspective because your ROE is much higher, but you also have a much higher capital base. So, I guess my second question related to that is you increased the payout this year above 80%. Could you continue to pay 80% or even more? I mean, as you showed, you have a very strong capital base, very strong ROE. So, what's the right capital level given that your peers' capital seems so much lower? Could you try to reduce that capital to deliver perhaps a higher ROE? Just want to understand how you think about that. Thank you.
Pablo Mejia, Head of Investor Relations
Hi Tito. Our guidance for return on average capital is around 18%, factoring in the capital levels at the end of 2024. It's important to note that we also paid out more than our established dividend policy, which is set at 60%. This guidance is based on a cost of about 1.0% to 1.2%, reflecting a conservative return on equity with potential upside. Currently, discussions around interest rates in Chile and possible inflation changes due to global market influences will also impact our return on equity going forward. While we are expecting to end the year with an 18% return based on our current economic outlook, the higher payout adjustments need to be taken into account. Sorry about that. Daniel, let's move on to your second question regarding capital.
Daniel Galarce, Head of Financial Controller Capital
Thank you, Pablo. Well, regarding capital, as you said, we have a very strong capital base, probably the strongest among the main peers in the Chilean industry. And well, the payout this year has to do basically with the results we have seen over the last year. But also we want to be prepared for the taking of the economy in the future and in order to have enough capital to grow as well and to address the final stages of Basel III implementation. So we want to be prepared for that. And to do that, we need to have enough capital in order to cope with that.
Tito Labarta, Analyst
Okay, but in terms of coping with that, I mean, there's 14% core Tier 1. Do you think that's the right level? It still seems pretty high compared to your peers. So just to understand, what do you think is the right level to deal with potential challenges?
Daniel Galarce, Head of Financial Controller Capital
We basically want to be above, of course, the regulatory limits and our internal limit as well. So in the long run, basically, we want to be around 2 or 3 percentage points over the regulatory limits in order to have enough capital to grow as long as the economy continues to grow.
Tito Labarta, Analyst
Okay. Great. Thanks, Daniel.
Operator, Operator
Okay, Thank you very much. Our next question comes from Mr. Yuri Fernandes from JPMorgan. Please go ahead, sir. Your line is open.
Yuri Fernandes, Analyst
Hi, everyone. Congratulations on another successful year in 2024. I have a follow-up regarding Tito's question on your return on equity. Your return on capital guidance is set at 18%. Can you clarify what would be divested from the new capital base? You have an 82% payout ratio, correct? Assuming you retain 18% of your capital, your average equity should see a slight increase in 2025 compared to 2024. For your return on average capital to drop from 23% this year to 18% without any adjustments, it suggests a significant decrease in earnings. I'm trying to ascertain if that's accurate, whether we should anticipate a decline in earnings for 2025 compared to 2024. Additionally, I'd like to know what will drive the free cash flow or inflation, and what's influencing that. Am I misunderstanding my calculations? The reduction from the 2023 return on average capital to 18% seems like it would bring about some challenges for you. Thank you.
Pablo Mejia, Head of Investor Relations
Hi, Yuri. Well, you have to take into consideration as well, our guidance that is based on our expectations for the economy, which may be a little bit different from yours, growth of 2%, CPI inflation, 3.8%. Some peers have higher than those levels and an overnight rate of 4.5%. So that obviously will have an effect in terms of these market factors on our bottom line. The levels being discussed today in the economy, Rodrigo can maybe elaborate on that, what's occurring in terms of inflation and rates?
Rodrigo Aravena, Chief Economist and Institutional Relations Officer
Hi Yuri, this is Rodrigo Aravena. When we created that base scenario, we made some assumptions, including one about interest rates. We anticipate a strengthening of the Chilean peso, which affects inflation. For reference, a 10% depreciation of the exchange rate would result in an inflation impact of around 120 basis points. This is why we view our forecast for CPI positively. Looking at the financial market trends, current financial prices indicate that the expected inflation rate is above 4%. In terms of economic growth, the last quarter surprised us with significant acceleration; we initially anticipated a 2.2% growth, but the final figure was 2.5%. This indicates that we are observing stronger-than-expected performance across various key metrics, particularly in domestic demand and inflation. Consequently, we can anticipate that the average inflation for this year will be higher than we initially expected, as will the interest rates. Therefore, we acknowledge this shift in our outlook. Pablo?
Pablo Mejia, Head of Investor Relations
To add to that, you should consider that last year marked the conclusion of the FCIC program from the Central Bank, which provided substantial funding for the banking sector. This low-cost funding ended in the first half of last year, and we no longer have that. This year’s rates are lower than last year, and the inflation expectations in their budget are also reduced. Additionally, regarding risk, we finished the year at a very favorable level of just over 1%. The expectation is for this range to be between 1% and 1.2%, which may slightly decrease that figure. However, the key point to consider is that the other operations are expanding. For example, customer income is increasing by 9%, and our net interest margins remain robust. We anticipate that net interest margins will be higher, likely steeper, than they were before the pandemic. There may be some inflation affecting net interest margins in the medium and long term, and we have good reasons to believe they should align with what we are forecasting for this year and into the medium term. This is positive news. Regarding our return on average capital, we aim to maintain the ROE at a level we’ve discussed internally, which is around 18%, or potentially higher depending on market factors and inflation. If rates climb higher and other conditions are favorable, these elements are crucial for us, particularly as we focus on digitalization. It is essential to consider all of this for future planning, ensuring that capital grows in alignment with loan growth. Capital cannot indefinitely expand; it must correspond with business growth, and our payout will always reflect this consideration.
Yuri Fernandes, Analyst
Clear. I guess, like bottom line is that you have some conservative assumptions here. I was asking this, Pablo, because just in the math here, 23% ROE going to 18%, it was implying, I don't know, mid-teens earnings decrease for you. This year was at 3%. And when I look to your guidance, as you said, like loan growth above the industry margins, some pressure, but minimal pressure on margins, cost of risk a little bit higher. So I think when I look to the ROE versus the order inputs, I don't have any impression that your earnings will decrease, I don't know, 10%, 15% whatever, maybe even show earnings growth. So I guess, correct me if I'm wrong, maybe the guidance was a little bit more conservative on the ROE. That's the bottom line, right, like.
Pablo Mejia, Head of Investor Relations
The return on equity, or ROE, reflects our return on average capital and takes into account the 60% payout, which will increase. Additionally, we consider that CIC is approximately CLP 90 billion to CLP 100 billion, which we no longer have. There's also a significant point regarding a 20 basis point increase in the cost of risk, particularly around the CLP 80 billion mark. The projected inflation is 4.6%, slightly higher than 4.5%, which gives us an additional CLP 50 billion. Many market factors are at play here. However, it's important to note that our other operations are showing growth, and there are improvements as Rodrigo mentioned. Efficiency is another key area; our costs remain relatively flat, and we are guiding an efficiency ratio of 40%. Market factors certainly influence this. While it’s true that the figure sits on the conservative side, around 18%, we must keep in mind that this is based on a 60% payout instead of the 82% or 83% we previously achieved.
Yuri Fernandes, Analyst
No, super clear. Thank you. And I guess you have the same in 2023. I think the ROEs were also the guidance was lower than the final numbers you had. If I may, just a second one here guys on margins. It has been super resilient and you comment on mix and better loan yields offsetting some of the pressure you see. When we go back to 2018, 2019, the Chilean banks, they had much lower margins than what you have. Should we think about this 45, 46, 47 as the new normal? Or should we see lower margins going forward for you?
Pablo Mejia, Head of Investor Relations
So it's important to mention that if we look at prior to the pandemic from 2010 to 2020, there was a strong mix in the loan portfolio. There was very strong growth in mortgage loans, for instance, and there was a period globally of very low interest rates and flatter yield curves. So those pressures continuously hurt margins during that period. But today, what we have is much higher NIMs, no, sorry, much higher interest rates versus prior to the pandemic and probably will stay higher than prior to the pandemic. This should probably be steeper. So that's why we're saying that in the medium-term and long-term, it's reasonable to assume net interest margins in line with our guidance for this year, for the longer term as well. So with these market factors, it's much more attractive for the banking industry than prior to the pandemic when rates were very low, which is more challenging to be a more profitable bank. And also, very importantly, we're leaders in terms of demand deposits, and this is a very good source of funding. It helps us to provide great customer service, but our brand and the quality of our service bring customers to Banco de Chile. We manage a very high level of demand deposits. So that also gives us a lead in terms of other banks regarding our net interest margins because of this low-cost funding base.
Yuri Fernandes, Analyst
So super clear, Pablo. Thank you. I'm not sure if Rodrigo wants to complement. Sorry for interrupting.
Rodrigo Aravena, Chief Economist and Institutional Relations Officer
No, we're not. I want to emphasize a point that Pablo already mentioned. The primary source of uncertainty concerning the future evolution of margins and returns relates to macroeconomic factors. As Pablo pointed out, the bank's fundamentals remain unchanged. For instance, the terminal interest rate in Chile during this cycle is uncertain; the Central Bank indicated in their last report that the new rate could be between 3.5% and 4.5%. However, due to ongoing discussions about inflation persistence, we can expect that the final terminal rate in Chile may be slightly higher than anticipated. Inflation affects the rate as shown in the monetary policy range over the past two years. Therefore, most of the adjustments in our guidance and forecasts stem from a changed perspective on the economy rather than any issues within the bank. It all comes down to macroeconomic factors.
Pablo Mejia, Head of Investor Relations
Yes. This will also influence the ROE, return on average capital for the future. The market factors will impact the industry.
Operator, Operator
Perfect. Thank you very much. Our final question for today is from Ms. Neha Agarwala from HSBC. Please go ahead, ma'am, your line is open.
Neha Agarwala, Analyst
Hi, thank you for taking my question. I have a quick inquiry about costs. You demonstrated strong cost control this year. What should we anticipate for 2025 regarding inflation? Will it be in line with inflation or above it? The efficiency ratio will depend on how revenues develop, so it would be helpful to understand your expectations for cost growth. I also want to revisit the topic of capital. You aim to be 200 basis points above the regulatory minimum, but with the dividend payout, your core equity Tier 1 is about 14%, and your total Tier 1 is above 18%. You are significantly above your peers. Why not commit to a higher dividend payout for a year or two? Is that something you will consider as you approach the end of this year? Thank you.
Pablo Mejia, Head of Investor Relations
Hi Neha. The first question I'll take. This is Pablo Mejia here. So, in terms of operating expenses and efficiency, we're seeing levels in the guidance around 40%, flattish expense growth. Obviously, the efficiency ratio is you have to take into consideration operating income. And there are some, as we mentioned, market factors, which could be changing that may influence the top line growth. So, that will influence the operating efficiency level. Some of the things that we've been doing and the bank has been very proactive in terms of cost management across the bank. So, we've been streamlining the business and searching for different operational improvements, there are incremental changes, improvements across different areas. We have a specialized area, which is looking at improving the efficiency, how we use our resources better using different platforms in order to reduce those costs even more. We're continually implementing new products and tools to automate processes and provide digital solutions to customers, which is twofold. It's better for the customer to have a better operating experience. And also, we also have a more efficient productive bank. We've also optimized our branch network and resource allocation. So we've actually closed 31 branches in the last year, which means we’re at 226 branches currently. So the banking industry globally is changing towards more digital, and customers are growing less and less accustomed to branches. So we have to offer the same solutions that we had before, and digital solutions should provide a better experience for customers and also offer us with a more productive bank. We've been doing other things such as improving marketing, changing how we do marketing, utilizing other online platforms, which have improved the expenses there as well, in terms of software licensing, managing our licensing better. So there's a lot of incremental changes across the bank that are helping to control expenses and keep the cost base relatively flat. So, with the top line growing more, if it grows more, obviously that will change the efficiency ratio, but the goal or the target of the bank is to have a relatively flat cost base for this year, 2025, and going forward is to keep it below 42%.
Neha Agarwala, Analyst
I mean that's quite commendable. I mean you had almost no growth in 2024 and you expect another year of almost no growth in terms of cost. Do you see more branches closing this year as well?
Pablo Mejia, Head of Investor Relations
We are currently working on optimizing our operations in Chile and determining where to allocate resources. Looking back, we had reached 450 branches, so most of the reduction or optimization of the branch network has already taken place. This is an ongoing process as we assess what that number will look like in the future. For questions regarding capital, Daniel Galarce will address those.
Daniel Galarce, Head of Financial Controller Capital
Hi, Neha. As I mentioned earlier, we have today a 14% CET1 ratio. That's true. And basically, in the future, we want to have enough capital buffers in order to address and afford potential growth of our balance sheet. As we believe that as long as the economy continues to regain some momentum over the next two to three years, we will need capital to afford that and address the final stages of Basel III implementation as well. Basel III implementation is still in progress. It's finalizing very soon. So we aim to remain prudent on how we face the future and, in this case, how we handle the growth of our loans as long as the economy regains momentum, as I said before.
Neha Agarwala, Analyst
Do you have any estimate on what could be the potential impact of the final stages of Basel III implementation?
Daniel Galarce, Head of Financial Controller Capital
There are still some things that need to be clear. Today, we have seen a decrease in the Pillar 2 charge in recent months. However, we cannot predict what types of charges the Chilean regulator may impose in the future. Since this regulation is still evolving and some aspects need further clarification from the regulator, we must prepare for potential charges, including Pillar 2 charges and additional requirements related to countercyclical buffers. To address this, we need to ensure we have adequate capital buffers going forward. More importantly, we want to have sufficient capital to support growth in the future, especially since our commercial business has slowed down over the last three years. We expect to see increased activity as the economy begins to recover.
Neha Agarwala, Analyst
Perfect. Thank you so much for the answers. Congratulations on the results.
Daniel Galarce, Head of Financial Controller Capital
You’re welcome.
Operator, Operator
Thank you very much for the question. We have no further questions at this point. I'll be passing the line back to the management team for the concluding remarks.
Pablo Mejia, Head of Investor Relations
Well, thanks for listening to our conference call, and we'll be happy to host you again next year. Bye.
Operator, Operator
Thank you very much. This concludes today's conference call. We'll now be closing all the lines. Thank you, and goodbye.