Brazilian banks are adapting themselves to an unusual environment: the prospect of long-run stability. The character of their institutions has to adapt to conditions of sustained growth, rising consumer incomes and corporate plans that extend beyond the next six months.
For years Brazilian banks got fat off lending to the government and conducting treasury operations. Corporate lending was restricted to a handful of top names and mortgage lending was only done to conform to government edicts. Lending to consumers used to be extremely tricky as volatility could easily upset their ability to repay and the legal framework was insufficiently robust to collect on bad debts.
Now some of the hottest segments are lending to small and medium-sized businesses and consumer finance. An interesting, new and extremely fast-growing business is lending against pensions and salaries. As banks are guaranteed repayment, this is being done at attractive rates that considerably cut the costs of borrowing for Brazilians with a regular income.
Looking further ahead, Brazilian banks are likely to carry greater proportions of loans on their balance sheets and a lesser amount of government treasury bonds. Interest rates (at 19.5%, among the highest real interest rates in the world) are set to follow a downward trend and banks will have to compensate for lower margins by increasing fee income and selling more savings and insurance products.
Brave new world
Will they be able to cope with a lower interest rate environment? “When margins come down, we will increase our lending. We will have more loans and lower delinquency rates,” says Márcio Cypriano, president and chief executive of Banco Bradesco, Brazil’s largest private bank by assets and the second largest overall by Tier 1 capital. “Currently one third of the balance sheet is loans. If the economy grows at 4%, we should be able to grow our lending at 16% a year, giving a ratio of 50% [of the balance sheet] in five years’ time.
“On top of that we will have increased sales of savings and insurance products that will contribute further to profits.”
Mr Cypriano points out that Brazil has been through economic sea-changes before that banks have had to cope with. “In the past, we had inflation of 80% a month and people said that when inflation came down the banking system would be broken [because of the loss of float profits]. In fact, Brazilian banks are very strong and able to cope with changes.”
Other bankers are similarly ready to embrace an era of stability. “We are totally prepared for the new stable environment, one in which there is not continuous stop and go cycles in GDP growth,” says Demosthenes Madureira de Pinho Neto, executive vice-president of Unibanco. “We have positioned ourselves more aggressively than our competitors to take advantage of stability.”
Mr Pinho refers to the shift in emphasis between wholesale and retail banking that has taken place at Unibanco. “Ten years ago, we were pretty much a wholesale bank and the culture was very much a wholesale one. In the late 1990s, we decided to put together a deeper retail franchise because wholesale margins were falling. We expanded the branch network through acquisitions and joint ventures with retailers, and we acquired Fininvest, which is the major consumer finance operation in the country.”
Stability will be a major driver of growth at Fininvest. “We will not need to be as cautious as we were in the past. Of 10 credit applications in consumer finance, we currently accept 3.5. This is like driving with the brakes on. We should be able to grow it much faster in future,” says Mr Pinho.
Retail focus
According to a Fitch report on Brazilian banking: “The most important trends emerging from the recent evolution of the banking system are: the growing appetite among large national banks and international banks for expanding their retail operations (basically consumer finance) through organic efforts and by acquisition of the loan portfolios of smaller institutions specialised in this niche.
“Since 2003, significant increase has occurred in partnership agreements with automakers, large retail chains and supermarkets… designed not only to expand the banks’ channels for product distribution and servicing clients and leverage their portfolios at more attractive rates, but also to enlarge their customer base and increase the likelihood of their becoming ‘banked’ in the future.”
For banks that do not have a core retail operation, different ways of exploiting stability have to be found. Banco Votorantim is part of Votorantim, one of the largest private industrial groups in Latin America. In the past, considerable profits came from the treasury operation and the lack of a retail operation was helpful: the last thing traders need is nervous retail depositors who might respond to a trading loss by removing their money and starting a run on the bank.
Corporate operations
Yet Votorantim cannot afford to ignore the new reality of Brazilian banking: consumers and companies will be the sources of future profits. “We will be growing the corporate side and reducing the treasury operation,” says Pedro Mullo, an executive at the bank. “As Brazil moves towards investment grade the treasury opportunities will lessen.”
Abraham Weintraub, the bank’s chief economist, says: “In the past, Banco Votorantim was successful in finding the best and most efficient solutions for Brazilian corporates in assisting them to avoid the turmoil. We are now preparing ourselves for a more stable environment. The bank will need to find solutions for exporters and inward investors.”
One area in which Votorantim can offer its expertise is in international capital raising. The bank has the experience of doing its own issues and can now offer this advice to others. It has raised $650m in international markets this year, including some issues denominated in reais (Brazilian currency), which is a sure sign of stability. The sovereign has also taken advantage of this environment by issuing internationally in reais.
Votorantim is not limiting itself to wholesale operations, however. The bank has already built up one of the largest car financing operations in Brazil with 7bn reais ($3.2bn) in assets. It has rejected the mortgage market as still too challenging because of the difficulties of recovery but it has joined with other banks in the payroll financing business. This business was made possible by changes in legislation.
“Raising money against pension or salary payments is one of the fastest growing businesses in Brazil,” says Antonio Quintella, CSFB’s Brazil country head. “The challenge for Brazilian commercial banks is to continue making money in a lower interest rate environment. The other big opportunity, if we see lower rates, will be real estate finance.”
Bradesco’s Mr Cypriano says: “There is huge demand and we expect our mortgage business to grow significantly over the next 18 months. We have introduced a product that is fixed rate for the first three years that is proving popular. The general landscape for the mortgage business has improved.”
The breadth of the Bradesco network assists the bank in winning business in consumer finance. For example in the market for lending to pensioners against their Instituto Nacional do Seguro Social (INSS) payments, of the 20 million Brazilian citizens eligible, Bradesco has four million as customers. Larger banks such as Bradesco have also signed operational agreements with smaller banks to provide funding for the latter’s pensioner customers.
Consumer orientation
Since Mr Cypriano became CEO of Bradesco in 1999, the bank has made substantial progress. It has bought 20 banks since 1997 and this has created quite an integration challenge. For some time, the bank lagged behind rival Itaú in terms of efficiency and creating a modern structure. But, under Mr Cypriano’s leadership, it has made huge improvements, winning The Banker’s Best Bank in Brazil award 2005.
“We increased costs during the acquisition process, and we had to rationalise the structure and reduce the number of branches. Bradesco used to be a product-oriented bank and now it is consumer-oriented. The segmentation process [of customer groups] began later at Bradesco than at Itaú but now the market recognises that we are totally segmented and there is no difference between ourselves and Itaú,” says Mr Cypriano.
The cost/income ratio has fallen from more than 60% to 48%. Investment in an SAP system has helped to decrease costs. Lower paid employees have been replaced by higher paid but better educated and more efficient staff. A next step may be to create a dedicated Bradesco investment bank by bringing together activities that are currently scattered through the group. “Our capital markets operations are very fragmented and we are thinking about bringing everything together in a single structure,” says Mr Cypriano.
Still in the balance
Brazilian bankers are contemplating stability but Brazil is not quite there yet. A long-running political scandal has not yet spilled over into the markets but the possibility still exists. Stability has also been helped by highly favourable external conditions.
Votorantim’s Mr Weintraub says: “There are two concerns: if the global economy goes into the Dark Ages, Brazil will suffer, we depend on the success of China and India for our exports; the other concern is that Brazilians could elect the wrong leaders. But it seems that Brazil is in a virtuous circle. Politicians that don’t behave well are paying the price. Institutions such as the press and the judiciary are getting stronger and able to keep politicians in check.”
Regulatory outlook
For bankers and investors, this is all good news but there are still some practical steps that need to be taken before they can fully take advantage of the new stability. Reserve requirements and capital adequacy ratios are extremely high in Brazil as the regulators have sought to keep banks safe.
They should be able to ease up on regulations a little in the future. Reserve requirements have already decreased from 55% to 45% of demand deposits but bankers are hoping for a further loosening. Brazil’s capital adequacy ratio is set at 11%, three percentage points higher than that recommended by Basel I.
“The 11% ratio is associated with the high volatility of the past. In a stable environment there is no reason to maintain it at 11%,” says Unibanco’s Mr Pinho.
The other area in which Brazil needs to see progress is corporate governance and, particularly, treatment of equity investors. Most Brazilian companies have different classes of shares, some with voting rights and some without. Typically owners have controlled their companies by holding the shares with voting rights and issuing non-voting shares to the wider investment community. The system is only just starting to change.
Last December, Bradesco granted tag-along rights to investors and the Bradesco board also has two independent members: Ricardo Espirito Santo Silva Salgado from the Portuguese bank Espirito Santo and Denise Aquiar Alvarez Valente from BBVA. Earlier this year US retailer JC Penney sold its controlling stake in Brazil’s Lojas Renner chain through a public stock offering, creating one of the first fully public Brazilian companies.
The virtue has to continue. Brazilian stability is indeed an unusual circumstance that requires adjustment. Investors and bankers are now looking forward to the day – still some way off – when stability can be regarded as wholly usual.
