The opportunities of privatization
Don't worry about risk and efficiency: that seems to be the lesson Brazil's banking sector can draw from its experience in recent months. The source of easy living is the government's insatiable appetite for borrowing. And in January this year that appetite became still more voracious as the country's debt - much of it denominated in dollars or dollar-linked - ballooned in local-currency terms following the devaluation of the real.
Brazil's 50 largest banks made an annualized return on equity of 43.7% in the first quarter of this year. That, admittedly, was exceptional. The figure for 1998 as a whole was 11.4% - about the level of returns the sector has enjoyed for the past four years. Most of the banks' profits - in normal years at least - are made by lending to the government. This year the banks have also had a one-off bonus because they also did well from the devaluation itself.
The emerging-markets crisis of the past two years has made it more difficult for Brazil to borrow from banks abroad. And this year access to decent terms on the international capital markets has become even more problematic for the government at a time when the fiscal deficit has remained high at close to 10% of GDP. So the government has become ever more dependent on selling domestic securities. The stock of domestic government bonds may rise to nearly R500 billion ($255 billion) by the end of this year. The large volume of issuance has pushed up yields on government paper. Those banks that hold a lot of government securities on their books - most of them - have raked in the profits.
Those banks that decided to stick to their core business of lending to companies and individuals have done less well. As the economy has suffered in the wake of the devaluation, some companies have had difficulties making loan repayments. "There are some indications of a deterioration in asset quality in the first half of the year," says Peter Shaw, Brazilian bank analyst at Thomson BankWatch. "But the economic slowdown has been less severe than many people expected and the banks have generally come through it well."
According to credit-rating agency Moody's, the bad loans of Brazil's biggest banks were equivalent to about 9.5% of all their loans in 1998 and most of that figure is accounted for by the country's state-owned banks. The level of bad loans at private banks is considerably lower than that and provisions more than cover the private sector's non-performing loans.
Lending has never been a popular activity for Brazil's banks. For years the country suffered chronic high inflation which encouraged an emphasis on cash management rather than developing credit skills. After inflation was brought down to double digits by the Real Plan of 1994 the banks began to develop an appetite for credit. Lending grew as a proportion of all bank assets. But it never grew to more than 55% according to figures from Moody's.
Loan starvation
Over the past year or so Brazil's banks have reduced their credit lines. Brazilian companies complain that they are being starved of credit. But from the banks' point of view this strategy makes good sense. Brazilian industry is likely to suffer if the economic downturn that has followed devaluation turns out to be protracted. Analysts expect the volume of bad loans to increase in the second half of the year. That would decrease the returns of lending in comparison to funding the government.
Any bank that chose to lend to companies and individuals rather than buying government paper would probably be doing its shareholders a great disservice. "The banks are aware of the risk of being dependent on lending to the government," says Shaw. "But they don't have very attractive alternatives, especially in the domestic market. They have come to the conclusion that there is more risk in lending to companies than in holding government notes. And if you look at what has happened in other countries, you would have to say that they are probably right."
As a result of this low exposure to credit, the banks have not suffered greatly from the economic slowdown. According to Brazilian economic consultancy Atlantic Rating, the volume of past due and non-performing loans of the 50 biggest banks barely increased in local-currency terms from December to March. At the end of the first quarter they stood at R4 billion. But the banks had increased their provisions from R6.5 billion at the end of last year to R7.4 billion by the end of March.
Brazil's banks are not only well provisioned, they are also well capitalized. The shareholders' equity of the 28 banks rated by Moody's was equivalent to just under 11% of their total assets at the end of 1998. Those assets are also highly liquid - not surprising considering that so much of their balance sheets consists of very short-term paper issued by one of the most profligate governments in the world.
But like the government, the banks are also heavily dependent on short-term funding. According to Atlantic Rating, 86% of the liabilities of the 50 largest private banks had maturities of less than one year at the end of December 1998. By the end of the first quarter of 1999 the proportion had risen to over 89%. In the wake of the crisis provoked by the real devaluation, it has become impossible even for the sovereign to borrow in the international markets at maturities of more than five years. For most of this year, the Brazilian government has been able to borrow abroad only at tenors of two or three years. Brazilian banks have found the international markets effectively closed to them this year.
Brazilian bank watchers have trouble determining the full extent of the Brazilian banks' exposure to government debt. Banking disclosure requirements have become more stringent in recent years but balance sheets are still far from transparent. Most analysts believe that government debt dominates the 51% of the banking sector's assets that are not loans. And the figure for loans also includes some lending to public-sector borrowers.