2010 guide to Brazil: Banking – Levelling the playing field
Praised for their role during the global financial crisis, Brazil’s state-owned banks now face calls to allow the private sector a larger role in lending and financing.
Just as in the general economy, the legacy of the success of Brazil’s banking and financial system during the financial crisis and economic downturn relative to the rest of the world is prompting deep questions about the future role of state-owned institutions in a domestic economy that has long since emerged from crisis.
To be sure, as Fitch analyst Shelly Shetty notes, Brazil’s entire banking system was resilient to the domestic and external credit crunch in the aftermath of the global credit crisis because of an absence of capital flight, lack of financial dollarization and a low dependence on foreign borrowing to fund domestic credit. However, no one in the banking sector begrudges state-owned banks the praise they have received for their vital counter-cyclical lending role.
"There is a feeling that state banks did as much as they could during the times of crisis. However, a new situation is now called for"
"Generally, there is a feeling that state banks did as much as they could [to support the economy] during the times of crisis," says Luiz Carlos Trabuco Cappi, CEO of Bradesco. "However, a new situation is now called for." Observers say that a new settlement must tackle the absence of a level playing field for private lenders, because it could hamper future growth, and the short-termism of Brazilian savers, who remain blinkered by years of instability.
The question is a pressing one. State banks accounted for 42.2% of Brazil’s credit market in July this year compared to 34.4% in September 2008. BNDES’s credit portfolio totalled R317 billion in July –11.7% up on the previous year, while Caixa Economica Federal, which had a 75.9% share in Brazil’s property credit market in June, grew its loan book by 58% in the year to that month. Banco do Brasil expanded lending by 29% over the same period.
In contrast, the loan book of private sector banks has grown by 25% in the past year as the economy has strengthened, according to Roberto Lampl, head of Latin American equities at Baring Asset Management.
No-one doubts that Brazilian private sector banks can continue to grow strongly. "The Brazilian banking sector is solid, with capital well above the Basel requirements of 8% at 18%," says Diego Donadio, head of foreign exchange and interest rate strategy for Latin America at BNP Paribas Brasil. Moreover, the sector is fairly well managed (the requirement for a $1.5 billion bailout of Banco Panamericano by Brazil’s deposit guarantee fund, Fundo Garantidor de Crédito, in November is a one-off event, according to analysts).
Instead, the crucial question is whether private banks will be able to make inroads into funding infrastructure development, increase long-term lending to corporates and continue to grow the retail mortgage market – to name just three segments – without a profound shake-up of how state-owned banks operate in the banking sector.
Increasing private sector lending
Possibly the most circular argument in Brazilian banking is about the involvement of private banks in funding long-term projects, such as the infrastructure developments that Brazil desperately needs, and more generally, in lending to corporates.
At the moment, the majority of infrastructure projects and a sizeable proportion of long-term corporate borrowing is accounted for by state development bank BNDES, which by virtue of its government ownership and an extremely favourably borrowing relationship with the government, is able to secure funds – and make loans – at rates that no private sector bank could ever compete with. "More than a fifth of all corporate loans ultimately come from BNDES, which gets some of its funds from tax proceeds and the Treasury lending to BNDES (using its assets as collateral), or through capital contributions to the bank," explains Baring Asset Management’s Lampl.
There are measures that could be taken to lower the cost of finance of private banks. For example, the central bank could reduce reserve requirements, which are currently 40%. "Reserve requirements are high by international standards and could be relaxed without endangering the financial system," says Lampl. "That would free up capital for lending purposes." Another suggestion would be to create a more effective credit bureau. "At the moment, Brazil only has a negative credit bureau which consequently does not reveal a borrower’s total credit history. If banks can price risk more accurately then they should be able to lower spreads," he adds.
Ilan Goldfajn, Chief Economist, Itaú Unibanco
Private banks – and Brazil more generally – also need to tackle the country’s historic short-termism, which results in low retail savings rates. "Depositors are unwilling to lock up funds because of memories of instability," explains Ilan Goldfajn, chief economist at Itaú Unibanco. "Consequently, banks cannot on-lend money long term. There has to be a major effort to try to change the habits of the public to create funds that the private sector can make use of." Tinkering with reserve requirements and improving the ability of banks to check credit histories would no doubt boost lending by private banks – and the importance of improving savings rates to Brazil’s future prosperity cannot be underestimated.
However, the scale of the gap between the cost at which BNDES lends and where private sector banks can lend – BNDES is able to offer long-term lending at around 12%: similar to what private bank might charge for short-term money, according to Lampl – means that only by constraining BNDES and other state-owned banks will private bank lending flourish. "The problem is that as much as is possible has been done with BNDES," says Lampl. "Its balance sheet can’t be stretched any further. The risk is that if BNDES continues to grow its balance sheet – or even maintains it at the current level – capital is not allocated effectively."
Equally, companies could become dependent on what is effectively subsidized funding when they need to diversify their sources of funds and assist in the development of the domestic fixed income market. In a worst-case scenario, which is not a threat at present, a massive BNDES balance sheet potentially has negative implications for the sovereign rating.
Mortgages: an opportunity for private banks
Brazil’s total credit as a proportion of GDP was just 45% in 2009 – lower than other emerging markets – although Bradesco expects it to grow to 48.1% in 2010 and 50.4% in 2011. One of the main reasons for Brazil’s relatively low loan/GDP ratio is the absence of a significant mortgage market. Although rising, mortgages represent just 3% of GDP compared to 10% in Mexico and Chile. "Future competition in the banking sector could centre on mortgages, which currently have a low penetration," says Bradesco’s Trabuco. "It an opportunity for private banks."
Significant progress is being made – mortgage loans as a percentage of total credit have risen from 4.63% in November 2005 to around 7.4% in September this year, according to Banco Central do Brasil, and the average tenor of mortgage loans has increased from 10 years in 2005 to 30 years in 2009. Moreover, since March 2009, the Brazilian government has promoted a R34 billion ($18 billion) programme called Minha Casa, Minha Vida (My Home, My Life) designed to make mortgages affordable to low-income families. "The government programme to create a mortgage culture among people earning three to 10 times the minimum wage could ultimately be transformational for Brazil," says Lampl at Baring Asset Management.
However, some major challenges remain. Chief among these – mirroring the situation in the broader Brazilian banking system – is the role of state banks and the difficulty of obtaining long-term funding.
Caixa Economica Federal provides mortgages both directly and by providing funding to private banks. Other existing sources of funding, such as savings and loans programmes, are simply not large enough to fund the market if it continues to grow. "They will be exhausted in two years at the current rate of growth," says Goldfajn at Itaú Unibanco. "Ultimately mortgage funding needs to come from the bond market, which is [fairly] illiquid even for five-year money at fixed rates in Brazil," says Lampl.
Octavio de Barros, chief economist at Bradesco, believes that the government will have to make a commitment to promote the bond market. "There is a need for an incentive because there is currently no interest in 10-year domestic bonds, for example," he says. "The government has announced that it is preparing changes relating to private fixed income securities, which could give the market a boost. Given the infrastructure needs [and impending mortgage needs] of Brazil, change is imperative."
If the government shows it can continue to manage inflation then the yield curve for government issuance could fall, paving the way for non-government issuance at attractive long-term rates, believes Lampl. "Pension funds could be instrumental in developing a lower yield curve but they won’t get involved until real rates come down," he says. "If rates come down to 7-8% then five-year paper could be issued at 10% and 10-year at 12%, which would make it worthwhile for issuers to raise fixed rate instead of floating debt."
Perhaps the most significant potential source of funding for infrastructure projects and mortgage lending is pension funds for state-owned company employees, which amount to R400 billion, according to Trabuco. "These are 70% invested in government securities. However, fiscal adjustment could lead to lower demand from the public sector for funding and freed-up funds could be directed to the private sector. In Chile, 50% of investment spending is funded by pension funds and that could potentially happen rapidly in Brazil."
Of course, one of the most important steps the government needs to take to facilitate a more liquid domestic bond market for bank borrowing is to stop issuing so much debt. "It comes down to the government addressing the fiscal situation and removing the crowding out effect," says Goldfajn. Douglas Smith, head of Latin America research at Standard Chartered, agrees: "With government debt paying 6-7% in real terms – and having not defaulted even during the 1999 crisis – it’s very difficult for anyone else to come to market and offer lower interest rates," he says.