Nov 3, 2014
Executives
Victoria Gabens – Investor Relations Pablo Mejia – Head-Investor Relations
Analysts
Tito Labarta – Deutsche Bank Thiago Batista – Itaú BBA Chris Delgado – J.P. Morgan Jose A.
Barria – Bank of America Merrill Lynch Boris Molina – Santander
Operator
Good morning, everyone and welcome to the Banco de Chile’s Third Quarter 2014 Results Conference Call. If you need a copy of the press release issued last Wednesday, it is available on the company’s website at www.bancochile.cl.
Today with us, we have Mr. Rodrigo Aravena, Chief Economist and Senior VP of Institutional Relations, Mr.
Pablo Mejia, Head of Investor Relations, Mr. Victoria Gabens, Investor Relations and Mr.
Daniel Galarce, Head of Research. 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 the forward-looking statements.
I will now turn the call over to Ms. Victoria Gabens.
Please go ahead.
Victoria Gabens
Good morning. It's a pleasure for me to share with you our comments on Banco Chile's third quarter 2014 financial results.
Please turn to slide number two. To begin, we'll discuss the developments in the economic environment and the results of the banking industry, followed by a review of Banco de Chile's results.
Please turn to slide number three, which contains the economic highlights. Several recent indicators have shown that domestic activity grew weakly during the last quarter.
Specifically IMACEC, which is the monthly proxy of GDP, posted a weak 0.9% and 0.3% annual expansion in July and August respectively, suggesting that the economic growth achieved its lowest level in the third quarter, nearly 1.2%. Although the breakdown of national accounts will be available on November 18, recent information suggests that private investment continues to be the main factor behind the slowdown.
Private consumption, however, is also weakening as a consequence of the higher inflation rate and the slowdown in waged employment. As a result, retail sales decreased by 0.9% year-over-year in September, after recording a weak 1.8% growth in August, whereas supermarket sales fell by 1.9% in the last month.
Please turn to slide number four. In spite of the weak figures, we’ve just mentioned, we believe that there is a high probability that economic growth will increase within the next few quarters due to three main reasons.
First of all, the Central Bank resumed its easing cycle in the third quarter by reducing the interest rate to 3.3% this month. This brings us to a total reduction of 200 basis points since October of last year.
Consequently, the interest rate is an expansionary territory, nearly 0% in real terms, while the long-term interest rate has reached its lowest levels. In this context, the Central Bank indicated a neutral bias in the press release of the last monetary policy meeting, suggesting that the interest rate will remain at the current level for a long-time.
Second, the government announced an expansionary fiscal policy for the next year. According to the budget submitted to Congress, which must be discussed and approved before the end of November, the fiscal spending will grow by 9.8% in real terms due to the 27.5% annual increase in civil works.
This is the highest rate since 2009. In this context, both increases in the size of civil works, which is in intensive in labor, and in the structural deficit to 1.1% of GDP, are a signal towards a more expansionary fiscal policy during the next year.
We believe that it is also worth mentioning that the fiscal position in Chile remains robust, as net debt remained negative at minus 5.8% in the second quarter of 2014. The third element is the positive impact from the weaker Chilean peso, which has depreciated by 14% in nominal terms over the last 12 months.
This should contribute to a recovery in the tradable sector, partially offsetting the slowdown in domestic demand. On inflation, the annual rate has increased to 4.9%, above the upper bound of the Central Bank range, which is between 2% and 4%, influenced by the weaker exchange rate.
However, we believe this high inflation rate is temporary, since we expect the looser output gap to lead disinflationary pressures from the demand side. In now, we expect the inflation to converge to a 3% target within the next few quarters.
Regarding the external accounts, both the weaker exchange rate and domestic demand have led to an improvement in a trade balance. Specifically, the rolling concept 12 month surplus increased to $7.2 billion in the third quarter of 2014 to $5.4 billion in the previous quarter.
As a consequence of 0.6%, annual expansion in exports and the 9.3% annual recline in imports. Please turn to slide number five, for a review of the main figures for the Chilean banking system.
As you can see on the chart on the left, there has been a downward credit growth trend in real-term, dropping from 8.4% in the third quarter of 2013 to an estimated 4.2% in the third quarter of 2014. This is completely in line with the decelerating economy, which has reduced demand and increased strict credit conditions set by banks.
Nevertheless, based on estimated information in the third quarter of 2014 figures seem to have decoupled and show a slight recovery when compared to the second quarter of this year. With regards to net income for the first eight months of 2014, the industry recorded an increase of almost 40% year-on-year.
This strong rise was mainly due to higher operating income from the extraordinary levels of inflation, which boosted net interest income as well as a more favorable funding and term gapping, given lower short-term interest rate and a steeper yield curve. As a result, the industry posted a very attractive ROE of 18% as of August 2014, which was well above the 14.9 % posted last year.
And now I’ll pass the call to Pablo, who will speak to you about this quarter’s result.
Pablo Mejia
Thank you, Victoria. On slide number six, you can see a snapshot of Banco de Chile's main income statement figures.
To begin, the third quarter of 2014’s net income increase almost 16% year-on-year. This strong rise was due to three main factors.
First, a non-cash accounting benefit of about CLP18 billion related to deferred tax assets. Second, a strong 12% decrease in provision expenses, and third an increase of 2% in operating revenues.
We will discuss all these factors on the following slides. Please turn for slide seven, here represent a breakdown of operating revenues, which is composed of interest income from loans, deposits, fees, and non-customer income, which is mainly related to income from activity such as funding and gapping, trading, and available for sale securities.
Operating income in the third quarter rose 2%. This increase was primarily due to our growth in net interest income from loans, which increased by 10% year-on-year, thanks to three factors.
First, a 7% increase in average loan volume, second, stable overall lending spreads, and third, an extraordinary gain of $9 billion from a commercial loan that was prepaid during this quarter. Also, we have been able to maintain the contribution from DDAs almost flat despite the strong decrease in overnight rate, by growing average volumes by 13% year-on-year, as customers prefer to maintain more liquidity in their account, the context of lower short-term interest rates.
Additionally, income was further increased by effective treasury activities, which offset lower inflation revenue almost completely. Specifically, we generated higher revenues from improved funding as a result of reprising short-term liabilities, benefitted from term gapping, and also realized important gains in the sale of available for sale securities as a result, an important decrease in long-term interest rates.
Lastly, these results were further enhanced by the positive effect of depreciation of the Chilean peso against the U.S. dollar asset positions that hedged our allowances for loans denominated in this currency, generating approximately $9 billion in higher operating income.
On the other hand, these results, due to the U.S. structural gap, we recognized less non-customer income than prior quarter, since inflation only grew 0.6% this quarter versus the 1% recorded during last, or over 1% recorded, more or less, over the last four quarters.
It’s important to note that there is a lag in the U.S. versus the consumer price index, which means that the strong CPI of 0.8% in September actually affects the U.S.
of October and November. In addition to inflation, fees continued to be under pressure, which is principally due to reduction in fees from our stock and insurance brokered subsidiaries, which was partially offset by attractive results in our mutual fund business, thanks to 30% increase in assets under management over the same quarter last year.
Moving on slide number eight is a review of our loan portfolio by segment. During the quarter, loans have grown 5% over the past 12 months and 2% quarter-on-quarter.
When compared to the same period in 2013, we can see a downward growth trend even if we exclude a loan portfolio purchased from a local bank in the third quarter of 2013 for $430 billion. This less dynamic activity is in line with the quarterly survey that was published by the Chilean Central Bank, which reported that banks have become more restrictive in overall credit conditions, especially in construction companies and SMEs, and also revealed that there continues to be a weaker demand from customers.
If we break this down by segment, our wholesale divisions present a slight decrease of 1.5% year-over-year, which is due to the high comparison base from the purchase of the previously mentioned commercial loan portfolio in 2013. If we exclude this, our growth in wholesale would have been 2.8% year-on-year, which is still a modest figure and reflects, on one hand, the weak demand from companies, and on the other hand our decision to maintain an adequate relationship between risk and return in the context of the current economic environment and high competition.
As a result of the weak demand for loans from larger companies, we grew 2.4% on compared to the second quarter of 2014. Going on, we continue to focus on growing selectively with high quality corporate customers.
Meanwhile, the retail segment has continued to show dynamism, with an increase of 11% year-on-year. This growth was primarily from mortgage loans and consumer loans in the middle and upper segments, which continued their strong growth trends, posting an increase of 14% and 10% respectively.
It's also important to note that this growth in mortgage loans has been accompanied by improved risk return relationships by focusing on the higher income segments, strengthening the effectiveness of our sales channels, and implementing important business intelligence tools to achieve share gains. These measures, among other initiatives, have also shown positive results in consumer loans.
With regards to SMEs, we have seen a slowdown in commercial loans, growing 7% versus 9% in the second quarter of 2014. This slower growth is due to the current economic cycle, which naturally affects this segment more than others, since they are financially more vulnerable in the context of a slowing economy.
Therefore, we have prudently tightened our acceptance criteria in line with our risk management requirements. In terms of the lower income segment, growth remained flat year-on-year, in line with the strategy put in place in prior quarters as a result of the diverse regulatory changes which have affected this segment, for example, the interest rate cap in regulations regarding insurance.
Before moving on, I think it's important to note that despite the current environment, we have continued to increase our customer base, as you can see on the right part of this slide. On average, we have grown our customers by 4.2% year-on-year.
This is very important because it allows us to diversify our customer base, permitting us to grow in demand deposits and loans while also providing opportunities to generate new sources of fee income, which is particularly important due to the various regulations that have been implemented over the recent years. Please turn to slide number nine.
Here we show a breakdown of our liability structure. As you see, the most important sources of funding are savings accounts and time deposits, demand deposits, and debt issued.
Over the past 12 months, these sources of funds have changed the most. The reasons for these changes are, first, we have continued to improve our DDAs, growing the end of quarter balances 7% year-on-year and average balances 13% year-on-year thanks to our customers’ confidence in the bank's solvency, and a greater liquidity preference from customers, particularly companies.
Second, the important decrease in time deposits, which fell 8% year-on-year as a result of a decrease in short-term interest rates, which have reduced the attractiveness of this product versus other product such as mutual funds and current account deposits. And third, a strong increase in bond issuance’s, which grew 26% year-on-year.
I feel the benefits of these changes are an increase duration of our liabilities, the diversification of our funding base by issuing bonds of other markets such as Japan, Switzerland, among others, and improving our cost of funds as the relationship between non-interest bearing liabilities to total liabilities has increased. In terms of cost of funding, we continue to maintain our leadership position in DDAs, and in bonds issued at very low spreads.
Also thanks to our solid business model and excellent credit rating, we are ranked amongst the safest banks in the world, and the strongest private bank in LATAM. Our cost of funding for the first nine months of 2014 is 3.6%, significantly below the system's average of 4%.
With regards to our capital adequacy ratios, we ended the period with a Tier 1 ratio of 10.3%, and a total capital ratio of 13.2%, well above the regulatory limits of 10% set by the regulator. Please turn to slide number 10.
As shown on the chart on the left loan loss provisions have dropped 12% from last year. The reasons for this decline is mainly related to the better overall credit risk behavior and to additional allowances set in the third quarter of 2013, as you can see on the chart on the right.
These positive factors were partially offset by a negative FX effect of about $9 billion on U.S. dollars denominated loan loss provisions.
This was a product of an 8% depreciation, and a 0.7% appreciation of the peso against the dollar in the third quarter of 2014 and 2013 respectively. All these effects consequently improved our loan loss provision ratio to 1.2% this quarter as compared to the 1.4% in the third quarter of 2013.
Nonetheless, these better credit risk results shouldn't be taken out of context, since we continue to see mixed trends in economic activity. While we expect the economy to begin showing signs of gradual recovery in the coming quarters, we can’t rule out the possibility that risk indicators could be affected as a result of the timing of when the recovery of the economy will begin, or the velocity at which it will recover could take longer than expected.
Please turn to slide number 11, for an overview of our operating expenses. As you can see on the chart on the left, operating expenses have grown 9% over the same period last year, and have remained relatively stable when compared to the previous quarter.
The main drivers for this increase are mainly due to an 8% growth in personnel expenses, which is principally explained by three factors. First, an adjustment in salaries, which are linked to inflation Accumulated inflation during the last 12 months, reached 4.6%.
Second, a slight increase in the number of employees, and third, higher expenses related to non-recurrent bonuses, specifically $1.2 billion associated to the completion of a bargaining process in one of our subsidiaries this quarter, and variable compensation associated with commercial campaigns. In terms of administrative and other expenses, these recorded a rise of 10% as compared to the same quarter last year, which is mainly due to inflation since some services are quoted in U.S., a rise in IT and other general administrative expenses, and impairments related to our branch and ATM network.
Even though inflation has dropped on an annualized basis below 3% this quarter, affecting negatively our operating income, we still managed to post a very positive efficiency ratio of 43.4% for the quarter. And for the year-to-date we achieved an efficiency ratio of 41.3% comparing closely with the leader in the industry and a large positive gap with the rest of our peers.
Our expectation for the long-term is to maintain a sustainable level of efficiency in the range of 42% to 44% through strict cost control policies, productivity improvement, and stable operating income growth. Pleas turn to slide number 12.
At the end of September, the government finally approved the tax reform. As you can see on the chart at the top of the slide, corporate tax over a five year period will gradually increase from 20% to 27% under the semi integrated system, and will go to 25%, if a company adopts the integrated system.
It's also important to take into consideration that the tax system must be approved in a shareholders’ meeting and requires the presence of at least two-thirds of votes. In accordance with this regulation, public companies must adopt by defect the semi integrated system.
As a result of the increase in corporate tax rate, we recognized a one-time positive effect on the P&L of approximately $21 billion due to the deferred tax assets, which was partially offset by the 1% tax increase applicable in 2014 taxable earnings, amounting to $3.4 billion. As a result the bank reported an effective tax rate of only 7.4% for the nine month period of 2014 versus the 13% recorded a year earlier.
Please turn to slide number 13. The first nine months of 2014 have been exceptional for Banco de Chile.
We have consistently posted strong results despite the slowing economic cycle, and we continue to lead the industry in terms of net income and profitability without steering away from our prudent risk policies that characterize us. It's important to highlight that 2014 results have been extraordinary for Banco de Chile and also for the Banking Industry, thanks to the high level inflation, and in a lesser degree to the one time tax benefit from net deferred tax assets.
These transitory factors, like the mixed economic trends mentioned earlier, should be taken into consideration when forecasting the performance of the Chilean banking industry for the following quarters. Finally, it's important to note that we continue to develop improvements in business intelligence, product innovation, risk management, operational processes, and technological infrastructure.
These elements should provide us with the long term competitive advantages that are particularly valuable for the challenging business environment ahead especially for the coming quarters, in which we'll face more competition from peers, lower inflation, and lower interest rates. Saying that we’re confident that we have the necessary abilities and tools to continue presenting better results than our competitors in this scenario.
Now if you have any questions, we would be happy to answer them.
Operator
Thank you. (Operator Instructions) And your first question will come from the line of Tito Labarta with Deutsche Bank.
Tito Labarta – Deutsche Bank
Hi. Good morning or good afternoon.
Thanks for the call. I just have a couple questions.
Your loan growth has slowed down quite a bit given the slowdown in the economy, yet you've maintained your asset quality relatively under control. Just wanted to get your thoughts on how you see asset quality evolving.
Do you think there could be some deterioration from here, given the bit of a slowdown you've seen? Just kind of what you expect there.
And then the second question, just if you can remind us of your sensitivity to inflation and how you see net interest margin evolving over the next year as you expect, you mentioned, inflation normalizing around 3%, how you see your margin will evolve on the back of that. Thank you.
Pablo Mejia
Thanks, just one second please. Okay, so in terms of risks.
Well, we’ve implemented a prudent approach in our acceptance criteria. If we look at what we’re seeing in the following quarters, we can't rule out a possibility of a slight increase in our loan loss provision ratio due to what we mentioned in the call.
There’s a lot of mixed trends that we’ve seen in the economic activity. It's also important to note that the loan loss provision ratio for the second quarter – for this quarter is very similar to the last quarter if we exclude the loan the countercyclical provisions that we had in the second quarter of 2014.
And in terms of our net interest margins, there's a variety of factors that you have to take into consideration when looking at net interest margins for the next quarter and then for the next quarter. The next quarter, obviously we have a high inflation.
We already know the September figure, which was 0.8%. So, that should boost our net interest margin.
But, at the same time, for next quarter and the following quarters, if the interest rates have dropped to around 3%, then we’re expecting another job probably next year to about 2.75% in the overnight rate. So, that will affect negatively the margins that we received from our DDAs.
And the inflation, it's important to mention for next year as well we're at a level of near 5% for 2014, if you look at four year figures. And for next year we’ll reach a level of around 3%.
So, that will have an effect in net interest margin. So, you should think of net interest margins decreasing for next year, because of inflation and the lower overnight rate.
Tito Labarta – Deutsche Bank
Okay, thanks. And just in terms of the asset quality, you mentioned you could see a slight increase in provisions.
Could you maybe quantify that? How much pressure do you think you can have in terms of asset quality and how much faster your provisions would grow because of that?
I mean, it is 10 basis points higher as a percentage of loans, if we can maybe just get a little more color there. Thanks.
Pablo Mejia
It’s difficult to say right now, because we’re seeing mixed trends in the economic activities. So we really need to see, how the following month evolve especially.
Because there’s still a lot of mixed trends coming out, for example unemployment, so that’s all we can say.
Tito Labarta – Deutsche Bank
Okay. All right.
Thanks, Pablo.
Pablo Mejia
Okay. No problem.
Operator
And your next question will come from the line of Thiago Batista with Itau BBA.
Thiago Batista – Itaú BBA
Yeah. Hi guys.
This is Thiago Batista speaking. I have two questions.
The first one is regarding the implementation of BIS III. Recently it was indicated that Basel III in Chile will be implemented during the first half of next year.
I know that we don't have the final details yet, but do you have any forecast on the potential impact of the BIS implantation on Banco de Chile? And my second question is regarding the SOAS tax suit.
Do you have any updated estimate on when the SOAS debt will be repaid and then Banco de Chile tax suit will end?
Pablo Mejia
Okay, thank you. In terms of Basel III, what we know now is that the regulators have a plan to change the banking law, and one of the key items of that banking law is to implement Basel III in Chile.
And from what we understand they would like to implement a process of Basel III soon. soon and gradually.
And another very important aspect of this is, from what we understand and what we expect, is that they'll take into consideration the realities of Chile, of the Chilean banking system, and not implement the full Basel III like you see in Europe, for example, similar what happened with IFRS, a re-implemented IFRS in the context of the Chilean banking industry. So, right now we don’t have that much information in terms how this will be implemented and the criteria that will involved in order to do a proper estimate.
And so it’s important to mention that the regulators, the Central Bank and the superintendency, have also recently published a comment paper and received comments from the banks in Chile regarding liquidity. So, the banks have provided our comments in terms of liquidity on this new liquidity measure, which is Basel III.
We also believe that this is to help banks implement Basel III gradually in the industry in Chile. And what the Central Bank here is asking is that it should – the liquidity requirement should the liquidity requirement should be for reporting purposes for now and not a requirement so that they can understand better the banking system’s ratios and, in the future, implement the requirements of reporting of liquidity levels.
And the second, in SOAS we have around – just under $1 trillion in debt per SOAS, which is a shareholder of Banco de Chile. It’s not debt to the Central Bank, isn’t a Banco de Chile debt.
It’s a debt from the shareholder. And if we look at the levels of dividends that we’re paying, SOAS, they receive about 30% of earnings of Banco de Chile.
And if we take into consideration, as a base scenario, the revenues that we generated last year for the full year, we should see probably a repayment, in simple mathematics, around – well, before the year 2020. As long as the baseline scenario remains.
Thiago Bovolenta Batista – Itaú BBA
Okay thank you.
Operator
Okay and our next questions therefore come from the line of Chris Delgado with J.P. Morgan.
Chris Delgado – J.P. Morgan
Hi. Thanks for taking my questions.
I just have two quick questions, one relates just to loan growth. Could you talk a little bit more about maybe your expectations for 2015, just given the slower growth that you guys have seen here, especially in the third quarter, and what that means for next year, and then just also if you could talk a little bit about maybe expectations for fee growth?
I don’t think there’s a much regulatory pressure as maybe what you’ve seen in the past two years, so if you could also talk a bit about that it’d be helpful.
Pablo Mejia
Hi, in terms of loan growth, what we are expecting for next year is GDP to be around 3% and for loan growth for the system to be around 5%, in what is that means for us, we think that we should be growing slightly above the market in both commercial loans and consumer loans. Obviously in commercial loans, looking to maintain a long relationship with our customers, we’d like to retake a little bit of the growth that we haven’t had this year.
This is our baseline scenario, which basically even though, we’ve seen some better demand this quarter, we need to wait for at least another quarter, to see when this recovery will begin or to have more lag than our baseline scenarios. So that’s very important to taking to consideration, to see how the economy evolves in the following months.
In terms of fees, I think fees – there’s been many regulations which have limited how we can charge for fees. For example, there’s been regulations on insurance premiums and the pricing has been fixed as well.
It’s difficult to change prices. So, we’re expecting – you shouldn’t expect anything near – you should expect less in loan growth – and one important thing of loan growth – sorry, when I said 5%, I meant 5% real, not nominal.
Chris Delgado – J.P. Morgan
Okay.
Pablo Mejia
So that would be 8% nominal. So, you should expect fee growth to be less than loan growth.
And I think it would be driven a little bit by customer growth as well.
Chris Delgado – J.P. Morgan
And then just one last follow-up question to that. Just kind of given the loan growth scenario and what you’ve talked about so far, like what do you guys still view as kind of an achievable ROE?
I think you guys have typically talked about something in the realm of 23% to 25%. Do you still think that’s the case, or do you think it probably falls a little below that, given the inflation scenario and the rate environment that’s playing out?
Pablo Mejia
I think it’s important to look at the long-term and we think that Banco de Chile is capable of achieving above 28% ROEs because we still have a lot of competitive advantages. In the short term, you have to think about inflation.
But, in the long term, you have to think about we have – we’re still a bank that’s still more focused in companies than retail. We have a lot of room to continue growing there.
And we continue to have some room in improving, I would say, in the long term – a sustainable efficiency ratio which was basically lower this year because of the high inflation. So we can – we’re expecting them to maintain a efficiency ratio between 42% and 44%.
So those things should be taken into consideration, In order to achieve this flat 20% ROE.
Chris Delgado – J.P. Morgan
Okay, great. Thank you.
Operator
And our next questions will come from the line of Jose Barria with Bank of America.
Jose A. Barria – Bank of America Merrill Lynch
Two questions, and actually just a follow up to your previous comments. Can you repeat again the target for ROE?
It got cut off and I couldn’t understand. And then, my two questions are – first is on provisions, specifically these countercyclical provisions that you guys booked in the last quarter, in the last year in the third quarter.
Just want to understand if this is something that we’re going to being seeing more of. I know in the last conference call you said that this decision is taken by the Board.
But, given the comments that you’ve made on the weak macro, it would seem that it seems more conservative. So, I was surprised to not see any countercyclical provisions booked this quarter.
I’m just trying to get an idea of what I should be thinking of in terms of provisions on a recurring basis, on a nominal basis or in terms of as a percentage of average loans. And my second question is with regards to some comments that you have on the release with regards to competition in the commercial space, the commercial segment.
You said that you've seen some aggressive practices from competitors. I was wondering if you could elaborate a little bit on that in terms of what you're seeing in that particular segment from competitors.
Thanks.
Pablo Mejia
For the first question on ROE, it’s important to take into consider the inflation for next year, so inflation will be much lower. But, we think in the long-term, Banco de Chile has sustainable or has the ability to have a sustainable ROE of above 20% for sure.
If we move to the countercyclical provisions?
Jose A. Barria – Bank of America Merrill Lynch
Yes. I'm sorry, Pablo.
Can I ask you just quickly on that, because right now you're at about 24% when we annualize the first nine months. And you've been around that level, understanding that that inflation was very high in the first half.
If we're talking about inflation at 3%, 20% sounds conservative. I mean, I don't – is there a reason we shouldn't be higher than that?
Pablo Mejia
Well, sorry, I’m saying in the long-term. So, that would be taking into consideration everything, for example, full implementation of the tax hike, for example as well there.
So that’s I’m saying over 20% in the long-term. For next year, it should be more than that.
Jose A. Barria – Bank of America Merrill Lynch
Okay.
Pablo Mejia
It’s should be less than this year, I wouldn’t say less, but I would say it's important to take into consideration that, but ROE for the medium-term and the long-term should be above 20%. And it’s very important to take into consideration that inflation was above normal this year.
So, next year we should have inflation of around 3%.
Victoria Gabens
So 1 percentage point of inflation, it’s about 1 point – affects ROE of about 1.5%.
Jose A. Barria – Bank of America Merrill Lynch
Okay.
Pablo Mejia
So.
Jose A. Barria – Bank of America Merrill Lynch
Okay. And before we go on to the other questions, you said an implementation of the full tax.
Have you guys decided already which method you're going to go with, or is it still being discussed, which of the philosophies?
Pablo Mejia
It has to be approved at the shareholders’ meeting, it’s a shareholders decision. The one that public companies have to take until it's approved is the 27% regime.
Jose A. Barria – Bank of America Merrill Lynch
Okay.
Pablo Mejia
And then at the shareholders meeting that can be changed, but…
Jose A. Barria – Bank of America Merrill Lynch
And no word on which way you'll go at that meeting or what will be proposed?
Pablo Mejia
There hasn’t been any word from the – it has to be decided in 2016.
Jose A. Barria – Bank of America Merrill Lynch
Okay…
Pablo Mejia
Second question – in terms of our policy for countercyclical provisions, it’s important to know that the policy is for additional provisions is to safeguard the bank against unexpected fluctuations in the economic activity. So, it's a Board decision.
They take into consideration what's going on. It's not a management decision.
In the case of – for the bank, this is – what I can say is it's at the Board level.
Jose A. Barria – Bank of America Merrill Lynch
Okay. So, what would be the – I'm trying to think here of what provisions should look like on recurring basis as a percentage of average loans, I guess we can call it, because if I look at this quarter, last quarter, and a year ago, you were at 1.4%.
But, that included these countercyclical provisions. Is the expectation that you – given what you're saying on the macro that we should see maybe a higher inclination to be conservative and book these countercyclical provisions, or we should eliminate that from our base case forecast for next year?
Pablo Mejia
As I’ve mentioned the countercyclical provisions are board level decisions. So they take into consideration the economic activity.
In terms of loan loss provisions, we believe it should be around the level of 1.2%, 1.25% and those in that range.
Jose A. Barria – Bank of America Merrill Lynch
Okay.
Pablo Mejia
For 2015.
Jose A. Barria – Bank of America Merrill Lynch
Okay.
Pablo Mejia
And the last one – last question was – can you repeat it please?
Jose A. Barria – Bank of America Merrill Lynch
Sure. It was with regards to some comments that you have on the release about the competition in the commercial segment.
You're saying that you're seeing some very aggressive practices from other players or from your main players. I was just wondering if you could elaborate a little bit on that comment.
Pablo Mejia
In general, it's related to wholesale. So, there's very – the competition is very high in Chile, especially with the medium and smaller banks where there has been a sector pricing spread.
But, what we're looking at doing is to grow selectively with very good customers and maintain a focus on generating long-term relationships with the customers. So we look at the overall profitability, but obviously, we try and take care of our spreads to have an adequate risk-return relationship.
But, it's what's been occurring in the last I would say couple of years high competition in the wholesale.
Jose A. Barria – Bank of America Merrill Lynch
But, are you seeing more aggressive – I mean, part of the – sorry to keep going on. Part of the explanation for the commercial loans not really growing year-on-year was higher competition.
So, this is obviously affecting you guys. Looking at the system, it's growing roughly about 7%.
But, you guys were lower than that year-on-year.
Pablo Mejia
We think that the – and the medium size banks have been very aggressive. It's also important to take into consideration, however, that we had a loan portfolio purchase last year, which changes the base comparison.
So if we exclude that we have a much better growth this quarter.
Jose A. Barria – Bank of America Merrill Lynch
Got it.
Pablo Mejia
Which was 430 billion pesos, the purchase of the loan portfolio last year.
Jose A. Barria – Bank of America Merrill Lynch
Okay, that's all. Thank you very much, Pablo.
Operator
(Operator Instructions) Your next question will come from the line of Boris Molina with Santander.
Boris Molina – Santander
I was wondering whether you could elaborate on two issues. The first one is if you have any idea of what are the tenets or other proposals for the proposed reform on labor legislation, if you have any indication of what could we expect on this?
And secondly if you could make some additional comments regarding the Basel III comments that the industry is making to the regulators in relation to the Chilean reality, which are the segments or the areas that are a source of concern that would lead the industry to ask for a differentiated treatment? If you have some sort of specific points that might be requiring special attention, I would appreciate it.
Pablo Mejia
Can you repeat the second question, please?
Boris Molina – Santander
Yes, you mentioned that – the implementation of Basel III, there were some requirements from the industry for the regulations to be adapted to the Chilean reality. And I don't know if this is just intended to address the issue of the liquidity coverage ratio, or if it's something related to the capital adequacy ratio or the net stable funding ratio, if you have more details on what are the specifics of the Chilean reality that need to be addressed in the regulation that the industry is proposing.
Pablo Mejia
Okay thanks. In terms of the labor reform, what I can say is in the next few months, the government will announce the dates that it should come up.
We don't have additional information regarding the labor reform. In terms of the Basel III, it’s also – but we’re talking about there about a Basel III implemented to take into consideration the Chilean banking systems reality, we don't have too much information there.
It's what the regulator has informed on different occasions. So we believe that will take into consideration certain things in those – in the implementation of Basel III in Chile.
But we don't have certain areas where they'll focusing on more or less.
Boris Molina – Santander
Okay, okay, thank you.
Pablo Mejia
Okay, welcome.
Operator
And currently, we have no further questions. I’d now like to turn the conference call back over to Banco de Chile for any closing remarks.
Pablo Mejia
Okay folks thank you listening and participating in our call. We look forward to sharing with you our next quarter results.
Bye.
Operator
Once again, we’d like to thank you for your participation on today’s conference call. You may now disconnect.