OREANDA-NEWS. Recent Puerto Rico legislation will force some entities to withdraw deposits from private banks in favor of the newly expanded government banking services of the Government Development Bank (GDB) for Puerto Rico, Fitch Ratings says. The rule requires the commonwealth's public corporations, agencies and municipalities (the instrumentalities) to place their deposits with the GDB and scales back the already limited availability of institutional deposits for local private banks' funding.

The expansion of banking services highlights the strategic importance that the commonwealth places on attracting accounts from the local banking sector to bolster the GDB's liquidity position. Many of the GDB's expanded services are being offered at no charge in an effort to achieve some savings for the instrumentalities.

The GDB's principal role is to make loans and advances to public corporations and municipalities and to promote the economic development of commonwealth. The GDB functions as a bank, fiscal agent, and financial advisor for government instrumentalities. Fitch rates the Commonwealth of Puerto Rico 'B', Rating Watch Negative.

In Fitch's view, the GDB's new product offerings, although rare for a policy and development bank, will help it compete with local commercial banks, given the operational uses of these government deposits. The GDB is not a member of the FDIC, thus instrumentalities depositing monies with the GDB are foregoing FDIC oversight and coverage powers.

We expect the impact to the liquidity positions of banks such as Popular Inc. and First BanCorp to be minimal as the GDB draws in more of the instrumentalities' deposits. As of year-end 2014, Popular had a total of \$1.4 billion in municipal deposits and First BanCorp had \$227 million, comprising about 5.6% and 2.4% of these banks' total local deposit base, respectively. A counterweight to the loss of these deposits is that because local regulations required instrumentalities' deposits to be collateralized, their withdrawal would free the private banks' collateral, which could be used to attract funding from other sources.

Puerto Rican banks' funding profiles have historically been weaker than their US bank peers given stronger reliance on noncore funding sources. This has long been a rating constraint for Puerto Rico's banks. In Fitch's view, the size of the local economy is limited in its capacity to support the funding needs of all the local banks. Thus the market is highly competitive among the six private sector banks, four foreign banks, 127 cooperative banks, and now heightened competition from the GDB.