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Brazil: Little margin for banking errors

When Brazil's stock and bond markets lost a third of their value in late October as part of the Asian contagion, the country's central bank intervened quickly to defend the real against currency speculators, raising interest rates from 21% to 43%.

The market turmoil created losses at financial institutions that had played a leverage game - borrowing dollars to buy Brazilian financial assets. But the question now is whether the government will be forced to continue to keep interest rates high to avoid a devaluation - and how much long-term damage to the banking system it would inflict.

"No country can afford 43% interest rates forever," says Robert Gay, managing director, Latin American research and chief strategist at Bankers Trust Alex Brown. "If we thought it was going to go on longer than three months, that's a problem."

Fearing an extended period of tight money, bank analysts are recalculating their 1998 earnings estimates for the biggest institutions. Brazil's privately-owned commercial banks are heavily capitalized, with an average 20 to one capital to assets ratio, so serious failures are not expected.

However, earnings hits could be severe should brutal interest rates continue for up to six months.

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