BRAZIL HAS SOME of the most profitable banks in the world. Returns on equity regularly exceed 40%, and institutions such as Banco Itaú are often held up as models of professionalism and excellence.
As Brazil struggles out of its latest economic crisis, however, its banking system will have to change radically, and start making money in areas it has long neglected. What’s more, the biggest player in international banking, Citibank, could make its long-awaited move into the country at any time. The future for Brazilian banks is not going to be easy.
If any country’s banking system has shown itself capable of withstanding enormous shocks and changes, of course, it is Brazil’s. The crises of 1999 and 2002 were only the most recent in a series of economic convulsions: you have to go back to the 1970s before you can find three consecutive years when GDP growth reached 3%.
Most of Brazil’s banks date back to the days of hyperinflation, with its attendant sky-high real interest rates. Back then, the efficient movement of money was of paramount importance. If your money can lose most of its value in a couple of days, it’s crucial that you can get it to a bank quickly and that the bank can immediately transfer it to where you want it to go. Brazilian banks, then, tend to have very extensive – and expensive – branch networks: Itaú, Bradesco, and Banco do Brasil each have more than 2,000 branches nationwide. For the same reason, Brazilian banks are generally technologically advanced, clearing cheques within 24 hours.
For all that Brazil’s banks are generally highly profitable, most of their income has traditionally come from holding government securities. If you are based in a risky country that doesn’t default, it’s almost impossible not to make a lot of money simply by rolling over sovereign maturities.
Concentration risk But no bank likes having a large part of its assets lent out to one creditor. So Brazil’s banks have been waiting patiently for interest rates to come down and lending to the private sector to increase since the Real Plan was introduced in 1994, more or less abolishing inflation at a stroke.
Banks have been steadily increasing their fee income over the past decade. For instance, things like charging for sight deposits never existed in the hyperinflationary years, but now account for between 20% and 40% of banking revenues. The banks have also been slashing staff numbers in each branch.
At the same time, the banking industry has been slowly consolidating around a few key players. The two biggest private-sector banks, Itaú and Bradesco, have been slowly and steadily buying up a stream of smaller banks and credit companies.
Neither will expand at any cost – Itaú famously pulled out of an agreement to buy IntesaBCI-owned Sudameris at the last minute, because of valuation disagreements – but each is clearly very competitive with the other, and determined to be number one. Recently, Itaú bought BBA-Creditanstalt after the Sudameris deal fell through, giving it for the first time a strong corporate-banking presence. Bradesco bought Banco Bilbao Vizcaya, and also supercharged its presence on the ground by buying Brazil’s postal bank, essentially turning more than 3,000 post offices into mini-branches.
The only other banks that really matter in Brazil are the second tier of private banks: Unibanco and the two big foreign-owned institutions, Santander Banespa and ABN Amro. Unibanco has long played second fiddle to Bradesco and Itaú, but the foreigners are much more aggressive. Santander bought Banespa, the state bank of São Paulo, just before Brazil devalued in 1999.
There was a lot of jockeying in the bidding process. Bradesco was interested in Banespa only insofar as it would keep the bank out of the hands of its great rival, Itaú. If Itaú wasn’t bidding, then Bradesco also wouldn’t bid, although it had an offer lined up just in case. Unibanco heard that Itaú wasn’t bidding, and so low-balled its own bid. Santander ended up winning by a huge margin, most of which was immediately lost when the country devalued.
Banespa has been very good for Santander, however, and is now posting returns on equity of more than 45% – the highest not only in Brazil but in all of Latin America. Santander has slashed costs at the formerly inefficient public-sector institution, and has turned it into a key asset that is central to Santander’s Latin American strategy. With the biggest and best bank in Chile, and an excellent franchise in Mexico as well, Santander is clearly going to be a strong competitor for the foreseeable future.
ABN Amro, on the other hand, has much less of a strategic interest in Brazil, despite now being bigger than Santander. It leapfrogged Santander when it acquired Sudameris – it originally lost out in the bidding to Itaú, and then stepped in with alacrity when that deal collapsed. ABN Amro now has an extremely strong franchise in Brazil, but that’s not something its shareholders in the Netherlands seem particularly interested in. They have marked down the company’s stock because of its large exposure in a risky country.
There are two views of what ABN Amro is doing in Brazil and whether it will stay. Many foreign banks are leaving. Lloyds is selling up, for instance, IntesaBCI sold Sudameris, and there is a general consensus that consolidation will continue, with the smaller banks being gobbled up by the bigger ones. In Brazil, the next tier down is largely foreign: institutions like HSBC and BankBoston look ripe for the taking.
Buyer with one eye on the exit That said, ABN Amro has an extremely well run, successful and profitable franchise in Brazil, and is certainly big enough now to be able to compete strongly with such rivals as Itaú. The question is whether ABN Amro bought Sudameris to consolidate its position in the Brazilian banking industry or simply entered into the deal because the combination of ABN Amro with Sudameris was worth a lot more than either bank on its own.
Sudameris was very strong in wholesale banking while ABN Amro had a strong retail presence from its acquisition of Banco Real – the two fit well together. Certainly, if ABN Amro runs into problems at home, the sale of its Brazilian assets would look like an obvious and relatively easy way of raising money. It could be that the Dutch are simply waiting for a rebound in the Brazilian economy before selling.
Eventually, however, there’s no doubt that the winners in the Brazilian bank wars are going to be those institutions that most successfully make the move from lending to the government to lending to the private sector.
Private-sector lending is not an easy business in Brazil. It is still a poor country, and individual loans are generally in the region of $50. Total bank loans to the private sector are just 28% of GDP, compared with more than 60% in Chile and more than 100% in some Asian countries.
What’s more, Brazilian banks have problems funding their loans. In most banking systems, the lowest-cost and most reliable source of funds is from deposits. That’s not the case in Brazil, where by law 25% of demand deposits have to be set aside for the agricultural sector, and where 60% of savings accounts are earmarked for housing loans. This means that banks have an incentive to sell riskier money-market accounts over more stable cheque account relationships.
There’s also the problem of competition with state-owned banks. A stunning 45% of the total assets of the banking system are still held in the public sector, if BNDES, the national development bank, is included. Even excluding BNDES, Banco do Brasil and Caixa Econômica Federal account for 38% of the system’s total deposits.
The public-sector banks compete with the private-sector banks without the same need for profitability.
This is an obstacle to be circumvented rather than tackled: there is no chance that any of the big public-sector banks will be privatized. For one thing, this would directly contravene the policies of the present Worker’s Party administration; for another, the public banks have proved invaluable in the past when the government has been able to order them to buy its bonds. At one point, Banco do Brasil was the single-largest holder of Brazil’s external debt, not even counting sovereign domestic liabilities.
Even with competition from the public sector, stringent compulsory-deposit laws, and falling interest rates, however, Brazil is still very attractive to the one big name that has yet to make much of a mark in the country – Citibank.
The international bank has been active in Brazil since 1915, but has never built up much of a retail presence there. For most of the past 10 years, rumours have been swirling around that it has been looking to make a major acquisition in the country, but nothing has ever materialized.
A big buy would make sense for Citibank. Jorge Bermudez, CEO of Citigroup Latin America, has expressed his interest in such an acquisition many times. After all, Brazil is by far the largest economy in south America, and Citibank is determined to be the dominant name in the hemisphere.
There are two relevant precedents: Citi’s acquisitions of Handlowy in Poland and of Banamex in Mexico. Both were the best banks in their respective countries, bought at a high price by a cash-rich Citi. If Citi is going to buy in Brazil, it’s going to buy big: that means one of the top three banks. None of them looks as though it’s for sale, although, as one analyst says, “if someone walks into your office with a cheque for $12 billion, it’s very hard to say ‘no'”.
Brazil, of course, is a far cry from Poland or Mexico, both of which were investment-grade countries on a strong convergence path with their neighbouring economic superpower. That could mean that Citi would hesitate before buying one of the big two banks. “The only bank that has the necessary size to get taken over by Citibank is Unibanco,” says Andre Loes, chief economist at Santander in São Paulo. “Itaú and Bradesco are too big for Citibank. Would Citi be interested in putting $15 billion in Brazil when Brazil is three or four notches below investment grade? I don’t see it.”
Citibank is also likely to be wary of Brazil after losing billions in Argentina, a country that was historically a much safer place to have operations. There seems to be one prudent course of action – especially considering the huge premium that Citi would have to pay for one of the big three banks. It could wait until interest rates fall, the economy starts growing, the banks stop making outsize profits connected to the riskiness of the sovereign, and Brazil becomes integrated into an American free trade area in the same way as Mexico was part of Nafta when Citi bought Banamex.
Mexican banks’ slow recovery In Mexico, the sale to HSBC of the country’s fourth-largest bank, Grupo Financiero Bital, for £750 million (US$1.2 billion) in December 2002, is a vote of confidence that Mexico’s banking system, which collapsed after the devaluation of the peso in 1995, is slowly recovering. However, only two Mexican banks rank among the 50 most profitable in this year’s Latin and Caribbean 100 table. Falling inflation, declining interest rates and intense competition are squeezing margins on traditional high-yield, low-risk investment in government debt.
Last year, consumer loans constituted less than 6% of the outstanding loan portfolio of Mexican banks, despite a rise of 40% last year in real terms.
Serfín, owned by Spain’s Santander Central Hispano, has issued credit cards in a bid to compete with non-bank lenders, such as Grupo Elektra, Wal-Mart and dozens of other retailers, who are the largest providers by far of consumer credit to the mass market, lower-income customer.
In Venezuela, a nation plagued by political problems, Banco Mercantil, the largest bank, has managed to increase its net profits by 20.1% on 2001. Posting the twelfth-highest net profits in the table is quite an achievement in a country where the overall banking system may have lost 25% of its deposits in the past year, GDP dropped by nearly 9% and, earlier this year, a two-month strike nearly crippled the country and its valuable oil revenues.
