The surprise decision by the Brazilian central bank to call an end to its easing cycle in May, because of concerns about emerging market volatility, has offered some respite to the banks that have been facing a drastically lower interest rate environment.
Candido Bracher, chief executive of Itaú Unibanco, gives a glimpse into the ferocity of the authorities’ push to reduce credit spreads charged by the banks as the central bank has been slashing the country’s base rate from 14.25% to 6.5% (a final further 25 basis point cut was expected in May).
“The banking sector is under severe pressure to reduce spreads,” says Bracher in a candid admission that the central bank’s move to reduce rates and fees on credit and debits, as well as overdrafts, is part of a coherent drive to reduce the ‘spread bancario’.
Congress is also expected to pass a law that will create an ‘opt-out’ rather than the ‘opt-in’ rule for the country’s positive credit bureau in a bid to boost competition. The central bank is also fostering a friendly regulatory environment for fintechs.
“All these changes do affect our income… and we think we are dealing with them, trying to be as efficient as we can,” says Bracher. “At the same time that the central bank is making these changes, they are trying to create conditions for the lowering of the spreads and the lowering of the reserve requirements.
“This is a trend, and there’s no resisting this trend. It’s also in our interest to increase the number of clients and to increase demand for credit. And this also happens as the rates go down.”
All the big Brazilian retail banks have responded to the falling interest rate environment by boosting the proportion of higher-interest rate segments, such as small and medium-sized enterprises and consumer loans. This is in part a deliberate strategy and in part the result of the subdued demand for corporate credit, as companies wait for greater clarity on this year’s presidential election before advancing investment plans.
Also the lower interest rate environment has led to strong competition from the domestic capital markets, as many companies can fund cheaper and longer than the bank market.
Itaú’s first-quarter 2018 results paint a stark picture. While consumer credit origination is almost back to 2014 levels – at 99% of the 2014 base – total credit is only at 81% of 2014 levels, and that is largely due to a failure of corporate credit to return to pre-crisis levels.
In the first three months of 2018 corporate credit origination was just 66% of that in the same period of 2014. Meanwhile, private securities issuance is running at 193% of 2014’s levels.
Bracher has in the past said that the investment banking fees generated by domestic securities issuance does not compensate the bank for lost interest income.
“This may be a permanent factor now, and the corporate portfolio is not expected to grow as we are seeing the growth in the individuals and SMEs portfolios,” says Bracher.
However some analysts, such as Bradesco’s Rafael Frade, question how sustainable this shift is, given the shortening duration of the SME segment.
Itaú’s net interest margin actually remained level in the first quarter (compared with the fourth quarter of 2017 but was down 60bp over the first quarter of 2017), driven by the change to the bank’s credit portfolio.
Asset quality continued to help, with consolidated non-performing loans down to 3.7% (from 4.4% in Q1 2017), thanks to improvements in the individual retail segment (4.6% from 6%) and SMEs (4.3% from 5.6%).
Corporate NPLs actually nudged up year on year, to 1.8% from 1.5%.
The resilience of asset quality, with NPLs at or close to historically low levels, is another factor.
Cynthia Cohen Freue, director for Latin America financial ratings at S&P, sees potentially negative outlook for asset quality in the consumer portfolios, because “low income levels as well as high unemployment have increased credit risk”.
The historically low NPLs, coupled with the bank’s need to boost credit growth, leads Credit Suisse’s Marcelo Telles to suggest that the bank’s credit origination policies are too strict.
As he says: “There is room for you to maybe loosen up a little bit and then accelerate your retail book further.”
Bracher refuses to entertain the underlying assumption.
“We have not changed our credit appetite, our risk appetite and we are not looking at doing this,” he says. “We believe a lot of the improvement comes not only from the improvement in the economy but also from an improvement in our credit models. At least for the short-term future, we are not considering reviewing our risk appetite.”
But the outlook for an improved economy is in question as economists cut GDP forecasts. UBS’s Brazilian bank analyst Philip Finch downgraded the country’s banking sector after the first-quarter reporting period.
“We have lowered our 2018 loan growth estimates for the four Brazilian banks under our coverage to 3.8%, from 4.9%,” he says.
“We have also reduced our 2019 estimates to 4% from 8%. Our revised forecasts still assume a cyclical recovery in sector lending but now one that is more muted and will likely take longer to materialize.”