nation's banks are among the soundest and most profitable in the world. Return on equity tops 20% at many of the big domestic institutions. But the legacy of crisis lives on. Banks remain tightly supervised, and legislation has been slow to allow banks greater leeway to develop new activities. "The 1982-83 bust traumatized the supervisory authorities," observed Armen Kouyoumdjian, an analyst with Interacciones Global Inc. in Vina del Mar, Chile. "So many controls and restrictions were imposed that the bottom line was a very healthy, but also very dull banking system that is still very constrained in what it can do." One problem for banks is the subordinated debt they issued to the central bank more than a decade ago to cover the bad loans the government took off their books. "This has seriously limited the profitability, internal equity generation, and capital strength of the banks that are still repaying this debt," Moody's Investors Service said in a recent report. Chile's banks still hold more than $4.8 billion worth of such obligations. Of the 13 banks that originally obtained government assistance, the agency noted, six have repaid their debts. Seven others - including Banco de Chile, Banco de Santiago, Banco Concepcion, Banco Sud Americano, Banco de A. Edwards, Banco BHIF, and Banco Internacional - are still using up to 70% of their after-tax earnings to pay off their tab. Despite this drag and a broad reluctance to allow banks to enter new business sectors, Chile's banks have been steadily boosting earnings, raising capital for expansion, seeking out merger partners, and diving into permissible sectors like consumer finance. Chilean banks earned a total of $417 million in the first seven months of this year, up 32.4% from a year earlier. Return on equity climbed to 18% from 17.2%, though there's a large gap between ROEs in the privately owned domestic banks and the large foreign banks. Among private-sector banks, return on equity averaged 21.9%, while foreign banks averaged 9.7%. Loans at Chilean banks increased sharply by 10.5% to about $36 billion, with a steep 27% rise in consumer credit and a 16.5% increase in mortgage loans. Consumer and mortgage loans, Mr. Kouyoumdjian emphasized, now account for 20.6% of total loans, compared with less than 10% at the end of 1992. The fast-growing consumer finance sector is proving to be particularly attractive to Chile's large private banks like Banco Osorno y la Union, which this summer successfully raised $140 million in capital to expand its corporate, consumer, and international banking operations. Other banks are pursuing a similar strategy, in many cases through separately managed consumer finance subsidiaries such as Banco de Santiago's Solucion unit, and Banco de Chile's CrediChile. Though many of these finance companies are small, analysts note that they have registered extremely high returns on equity - 39% in 1992, 65% in 1993, and 55% in 1994. "Banks have realized that middle- and low-income consumers in Chile offer tremendous potential," said a recent report by Salomon Brothers Inc. "The levels of indebtedness of Chilean families is still low."

By and large, consolidation has been slow to get under way in Chile despite the merger announced last month between Banco de Santiago, the country's second-largest bank after Banco de Chile, and Banco O'Higgins, the third largest. The deal will create a combined institution with more than $8 billion in assets and about 16% of the domestic lending market. "The changes in the concentration index in Chile over the past several years were mild compared with those in Argentina and Brazil," another Salomon Brothers report noted. This stabilization, it said, can be explained mainly by the fact that "the Chilean banking system did not endure periods of hyperinflation followed by quick adjustment periods in recent years." Analysts like Jorge Mariscal, chief equity strategist for Latin America at Goldman, Sachs & Co., believe the merger is a sign of a worldwide effort among banks to reduce operating costs, rather than the first in a coming wave of consolidations in Chile. "What you see is a trend toward greater efficiencies that is mostly driven by technology," says Mr. Mariscal.

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