Brazil’s banks are anticipating that the country’s unprecedented economic stability will open new markets and, having survived interest rates of 50% and inflation over 2500% in the 1990’s, that they are in the best position to meet the new demand.
With annual turnover of $TK billion, Brazil’s banking industry is the biggest in Latin America. Since a cycle of consolidation in the 1990’s, four local players have come to dominate; Banco do Brasil, Bradesco, Banco Itau and Unibanco; along with stiff competition from multinationals like Santander and HSBC.
Meanwhile, Brazil’s macroeconomic fundamentals have improved drastically since the IMF bailout of 2001. “We live in a different environment to that of the years behind us,” according to Roberto Egydio Setubal, President of Banco Itau, Brazil’s largest privately owned bank.
The government is using swelling foreign reserves and a strengthening currency to pay off its external debt. Inflation is down to 7.6% and the trade surplus is running at over $40 billion a year for the first time since Brazil opened its economy in TK.
Regulation and reform of the banking sector has also helped. According to Setubal, the regulatory environment has fostered competition and innovation. For example, the government has not obstructed bids by foreigners to acquire Brazilian banks.
The key driver of business will be a cut in the interest rate from its current 18%, which will encourage firms and consumers to borrow. Setubal predicted that the process would begin this year. The high interest rate has discouraged banks from lending to the productive sector of the economy, because of the high returns to be had from investing in government credit.
However, private investment in government bonds is coming down, from around 30% of GDP in 2004 to 27% last year, according to Jose Maria Rabelo, Senior Vice President at Banco do Brasil, Brazil’s largest bank, 71% of which is state-owned.
Fast-expanding industries, which are hungry to expand capacity, include oil production, hydropower, and also agribusinesses like soy and sugar/ethanol.
The other great opportunity on the corporate side is in products that allow investors, both local and foreign, to access Brazilian capital markets. The secondary market for corporate bonds in Brazil is picking up:
“The public sector’s technical capacity and professionalism when it comes to managing funds has improved,” said William Bethlem, head of international banking at Unibanco. “They are investing their pension funds and the secondary markets have become more liquid”.
As Brazil’s sovereign credit rating quickly approaches investment-grade, demand is up for “anything that allows outside investors to enter the domestic market and access that high interest rate,” he added. “We’re developing new derivative and structured products that can be traded both inside and outside Brazil”. He predicted an increase in corporate issuance on the international markets by rail and road companies, and said there is a need to ease access to capital by simplifying the process of registering new equity or fixed income issues.
As growth picks up and incomes rise, the consumer market will also offer new opportunities that will be reflected in corporate issues: “Any businesses involved in consumer goods: electronics, supermarkets, air travel will all grow,” added Bethlehem.
Compared to the United States: “We’re ten years behind,” said Setubal, of Brazil’s consumer loan industry. Consumer credit, and credit to small firms should grow at 30% to 40% a year through 2006 and 2007. However, he would like to see an improvement in information on individual and company credit ratings, which enables banks to develop “positive track records for our clients as well as negative ones”.
On progress still to be made, Setubal said that there is room for to reduce the burden and complexity of taxes on banks: “The system can be made more efficient... we have direct taxes on interest, transaction taxes, high reserve requirements, taxes on financial intermediation.” However he acknowledged that reducing taxes is “much easier in a growth environment” and will probably happen slowly.
The government has made a start on cutting taxes on financial transactions. In February of this year it announced measures to cut taxes on foreign investments in locally issued public debt, and tax-free migration for foreigners between equity and fixed-income instruments.
But as Brazil’s capital markets open up, so will competition for the Big Four. Bethlem said: “Our major challenge is not the other Brazilian banks but global players who have global distribution, particularly in Asia, as it becomes an important source of capital”. However, he added that there was time for Brazilian banks to adapt: “The Brazilian credit market is still a domestic game”.
“Domestic capital markets will grow a lot and that will be to Brazilians banks’ advantage.
“We have the geographical coverage. We’re well positioned to exploit opportunities with fast-growing local companies”.
Rabelo at Banco do Brasil is more precise about the edge the Big Four have over their international counterparts. Having seen off two financial disasters in the last decade, he is confident that Brazil’s banks are better positioned than anyone else to exploit new opportunities in the country: “Only the strong survive”.