OREANDA-NEWS. The stable 2016 outlook for Chilean banks is based on strong credit metrics, according to Fitch Ratings. Standalone creditworthiness continues to drive most of large and mid-size Chilean banks. However, there could be very limited upgrades of Viability Ratings (VRs) in 2016. The timing will depend on the success of further business model diversification and maintenance of sound credit risk profiles under economic slowdown.

Chilean banks have a proven track record of stable results through the economic cycles, showing resilience to international volatility, with more predictable profitability, assets quality ratios and internal capital generation than their regional peers.

A negative outlook for the sector could be triggered by a stronger than expected slowdown in the domestic economy, which could lead to significant deterioration in the system's credit portfolio quality and operating profitability. However, this is not Fitch's base case scenario for 2016.

Progress in local regulations on the road to Basel III would be positive and necessary for the Chilean banking industry, as that would help banks to converge towards stricter international standards in terms of capitalization.

In 2016, Chilean banks will face a third consecutive year of economic slowdown (with a GDP average growth at only 2% for 2014 - 2016). While Fitch Ratings doesn?t expect a significant impact for Chilean banks, this will likely put pressure on their lending growth rates, profitability and asset quality. Credit expanded 7.5% during the first nine months of 2015, in line with Fitch projections (8% - 10%), while it is expected to move at a slower pace in 2016 (6% - 8 %).

Having anticipated this scenario, recent loan growth has been more concentrated on higher-income segments of the population. However, over the medium term, Fitch expects further pressure on credit costs, arising from adoption of standardized regulatory models for mortgage loans in January 2016.

The Chilean banking system has historically focused on commercial banking, mainly locally. However, in the past few years, local banks have initiated an internationalization process, primarily in Colombia and more recently in Miami, in the U.S., which may bring changes to how those banks operate.

Chilean banks have a proven track record of stable results through the cycles, showing resilience to international volatility, with more predictable profitability, internal capital generation and portfolio quality than their regional peers. Fitch expects operating profitability to remain constrained by lower inflation and the contribution of sight deposits due to the decrease in short-term interest rates, in addition to the effects of slower loan growth, a moderate increase in loan loss provisions and higher corporate taxes.

Although there has been no increase in the 90 days or more non-performing loan (NPL) rate during the first 9-months of 2015, Fitch expects a moderate deterioration in loan quality in 2016 due to the persistent slowdown in the economy and the resulting impact over small and mid-size companies, unemployment and specific corporate loans (especially considering recent leverage trends on the segment). Current NPL ratios are near record lows. Risk management, provisioning and monitoring practices remain robust for the system.

The banking system continues to face the following challenges: increasing core capital to support future growth in a lower profitability context, and likely higher requirements as Basel III rules are adopted. The replacement of complementary capital instruments that currently do not absorb losses before the entity reaches non-viability will be a key issue and the local regulator still hasn't established the parameters for a possible improvement in complementary capital.

Basel III liquidity rules will help to establish greater discipline in the local market, especially from small and medium-sized banks and specialized banks.