Banking: Quick recovery, enviable outlook

Brazil’s banks have reason to feel pleased with themselves. Spanish group Santander‘s IPO of its Brazilian business last month was the world’s largest so far this year and destined to fund rapid expansion. It was embraced by investors and the bank offered extra shares to meet demand.

The central bank, once seen as stiflingly over-cautious, is now a model. Tight regulation forces simplicity and caution on banks. Reserve requirements are higher than Basel recommendations and the central bank has control over non-financial subsidiaries of financial institutions while requiring all operations to be kept on balance sheet. The result has been a quicker recovery for the sector than in much of the rest of the world.

The long-term outlook is attractive too. Brazil’s banking market enjoys enticing profitability, particularly thanks to wide spreads on lending.

The country has the dubious honour of being one of only four countries in the world that reports average spreads above 30 per cent, according to the World Bank. With base interest rates still close to double digits – the benchmark Selic was at 8.75 per cent at the end of October – bank profits on loans are consistently high.

There is a great thirst for credit, as interest rates have come down after years of rates that made loans prohibitively expensive for most borrowers. Overall credit expanded by 31.1 per cent in 2008 and 27.8 per cent in 2007. There will be more growth this year.

In recent months, private sector giants Itaú-Unibanco and Bradesco have been raising estimates of new lending, says Celina Vansetti-Hutchins, senior analyst at Moody’s. Yet in spite of the heady growth, there is plenty of scope for expanding loan books.

In 2007, credit amounted to just 50 per cent of gross domestic product, compared with 169 per cent in the US, according to a World Bank report.

Given the opportunities, it is little wonder that the industry has been going through a wave of consolidation. Last November, Banco Itaú and Unibanco, two of the country’s largest private banks, took the market by surprise with the announcement that they were to merge.

That deal was thrashed out in a smart São Paulo apartment by the two presidents.

Nevertheless, it has been in the public sector that acquisitions have been most surprising. The country’s largest bank, state-owned Banco do Brasil, continues to swallow small competitors like canapés.

Moreover, by investing heavily in technology and customer service, it has overcome its reputation as a sleepy and bureaucratic institution, says Ivan Monteiro, chief financial officer. Today, it is becoming a formidable rival to private sector competitors, he says.

In the past two years, Banco do Brasil has absorbed two state banks and recently took over São Paulo-based Nossa Caixa, which has a rich mine of relatively untapped clients to exploit. The Brasilia-based bank also bought a 49.99 per cent stake in the troubled and privately held Banco Votorantim, which belongs to the industrial conglomerate of the same name, which is ranked seventh by assets.

It is not resting on its laurels. Banco do Brasil has said it would like to add other states’ public banks, including Banco do Estado do Rio Grande do Sul, in the country’s rich south.

The question facing private banks is what role Banco do Brasil will play in the everything-to-play-for credit market. President Luiz Inácio Lula da Silva has long been an advocate of increasing consumer access to borrowing, and a central plank of government policy is to bring down spreads. He has been vocal about achieving this aim through the use of public banks. In April, Banco do Brasil’s management, which was resisting government plans, was replaced by a more accommodating team.

Higher lending at the state bank is already showing up in its results. Banco do Brasil’s second quarter lending was increasing at a rapid clip. As other banks reined in, it expanded its credit portfolio by almost a third from the second quarter of 2008 to R$252bn (US$144bn).

Over the same period, newly merged Itaú-Unibanco expanded its credit portfolio by 15 per cent to R$266bn, compared with the second quarter of 2008. With the economy recuperating fast, the state bank’s move looks shrewd.

Banco do Brasil’s aggressive lending has touched a nerve with private banks. Roberto Setúbal, CEO of Itaú-Unibanco, recently insisted that public sector banks were not lending in a sustainable way.

Guido Mantega, the finance minister, was equally quick to retort. “It’s good that [private banks] wake up or they will lose more market share ... If [private banks] don’t follow Banco do Brasil’s example, they will eat the dust of public banks.”

Ebullient growth rates in credit mean that, although there will be pressure on spreads, credit will remain a profitable activity.

“We have the capacity to perhaps double credit-to-GDP ratios here in Brazil and a figure of 80 per cent would be healthy. Our financial system is more conservative and solid than most,” says Aldemir Bendine, president of Banco do Brasil. And, with the exception of Santander, the winnowing of competitors continues.

Government pressure for more lending is likely to ease, as the economy recovers and private banks return to lending more vigorously.

Tougher competition from a more efficient state bank and one of the world’s top financial institutions should also continue to modernise the banking system and enhance competition.

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