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AmericasJuly 2 2006

Reaching out for customers

Brazil’s banks are finally opening their arms to wealthy and lowbrow consumers and businesses alike. But interest rates remain high. Jonathan Wheatley reports.
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Recent television advertisements for Bradesco, Brazil’s largest private sector bank, open with an aerial camera shot travelling lazily across a typical Brazilian beach scene of Atlantic forest meeting the rocks around an arc of golden, sparsely populated sand lapped by a turquoise sea. “This is good,” reads a caption. The camera moves along to an equally idyllic neighbouring cove, this time with just a single small group of sun-worshippers. Another caption appears: “This is prime.”

Until recently, Bradesco was regarded strictly as a ‘popular’ high street bank, with a reputation for basic standards of infrastructure and customer service that bordered on the cheap. That it is now appealing to the wealthy in such an unashamedly elitist manner speaks volumes about the recent evolution of Brazil’s banking sector.

Brazil’s banks used not to behave very much like banks at all. During years of high inflation until the mid-1990s, their business consisted largely of taking deposits (and protecting them against inflation) and investing the money in government debt (earning vast premiums over and above inflation). Lending was not an activity that attracted much interest or attention.

Loan boom

With the end of high inflation, this situation has undergone accelerating change. Bradesco’s loan portfolio, for example, was 95bn reais ($43bn) at the end of the first quarter, a near 27% increase on its portfolio of 75bn reais a year ago. During the same period, total assets increased by 13% from 191bn reais to 216bn reais.

Break the numbers down and the picture becomes even clearer (see table download file). By far the biggest growth area for lending at Bradesco – and other banks – is to consumers.

“In the past, the whole structure of the banking system was directed at capturing deposits,” says Márcio Cypriano, president of Bradesco. “When inflation stopped, banks had to start lending but we had no tools for credit analysis. So in 1994 and 1995 there were big losses. Since then we have invested a lot in credit tools.”

Even after inflation fell from mid-1994, with the introduction of Brazil’s new currency and its eponymous inflation-beating programme, the Real Plan, interest rates remained very high. This provided a lasting disincentive to lending, as banks could make much bigger profits by putting all available money into almost risk-free government domestic bonds than they could by lending to highly risky consumers or businesses.

Falling rates

As the economy has stabilised and the risk of either a speculative attack on the currency or a sudden return to high inflation has subsided, interest rates have come down. Yet they are still very high. The central bank’s target overnight rate is running at about 15% a year. But this is its lowest level in more than five years, and the banking industry is hovering around a tipping point at which it becomes more advantageous to take the risk of making loans than to sit on government debt.

Indeed, Mr Cypriano says this point has already been left behind: “The only money you put into public debt these days is the money that you can’t find an application for elsewhere.”

This may be overstating the case. Credit in Brazil is still equal to less than a third of gross domestic product (GDP). That compares with 70% in Chile and well over 100% in many developed economies. Yet growth is coming quickly, and not only at Bradesco.

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Roberto Setúbal: no real expansion bottlenecks
Roberto Setúbal, president of Banco Itaú, the second-biggest private-sector bank, says his bank is on target to expand its credit portfolio by about 25% this year.

Delinquency growth

Expansion has come at a cost. “The rate of non-performing loans has grown since last year,” Mr Setúbal concedes. “My perception is that the rate has stabilised now, but it is at a higher rate than last year.”

Mr Setúbal says the increase in delinquency last year was a consequence of higher interest rates – the central bank’s overnight rate reached a high of 19.75% from May to September last year. “Now interest rates are falling and we believe economic growth will be stronger this year, so delinquency should be a bit smaller. Last year, we saw a big volume of new loans being taken on in a low-growth environment. This year, growth will be faster and delinquency should fall in the medium term.”

Itaú’s rate of past due loans rose sharply from 4.4% in the first quarter of 2005 to 5.2% in the first quarter this year. Other big banks reported similar levels, although Bradesco’s rate is running at between 3.4% and 3.9%, Mr Cypriano says, taking some satisfaction in saying his bank is further along the lending learning curve.

Whether high lending rates reflect high delinquency rates or vice versa is a moot point, but Brazilian lending rates are extremely high. Personal loans cost more than 80% a year. Overdrafts and credit card loans often command rates of well in excess of 100% a year. Even auto loans – one of the few areas where lenders can (relatively) easily get their hands on collateral – cost about 34% a year.

One area where rates have decreased is in so-called credito consignado, or payroll-linked lending, in which repayment installments are subtracted from borrowers’ pay packets or pension payments. Such loans command interest in the region of 34% a year, which is still an attractive spread for lenders, especially given the almost zero risk of delinquency.

Growth in payroll lending has been extraordinarily fast. It was introduced in 2004 and already accounts for half of all personal lending in Brazil, although the annual rate of growth had slowed to 15% by the end of April this year from 35% a year earlier.

It has become a favourite of middle-market banks and attracted some controversy this year when rates for loans to pensioners began to rise beyond what the government saw as reasonable levels.

The reason was that banks were paying commissions to sales representatives who began ‘auctioning’ lending rates among competing banks. On May 31, the government capped pensions-linked loans at a monthly rate of 2.9%, equal to 38.7% a year. Bigger banks had been charging rates in a range of about 1.75% to 3.15% a month for pension and payroll lending, depending on the number of instalments.

Rap on the knuckles

When the government set its cap, banks quickly adjusted all rates to the new maximum. The measure is due for review in August and may be revoked having served as a warning against further abuse.

Yet, even if the rate of growth of payroll lending has slowed, expansion of credit is one of the drivers of Brazil’s economy this year. The economy as a whole expanded by 1.4% in the first quarter over the final quarter of 2005, putting the government well on course to achieve its target of 4.5% growth for the year. Consumer borrowing and spending is growing at a far faster pace, however.

Personal credit expanded by 5.4% in the first quarter over the final quarter of 2005. This helps to explain why many Brazilians have such positive views on the economy at present, even though year-on-year growth to the end of the first quarter was just 2.4%.

Inflationary pressures

In many countries, the idea of consumer borrowing and spending so far outstripping overall growth would be enough to raise alarm about inflationary pressure. Yet Mr Setúbal at Itaú argues that Brazil can maintain credit expansion at present levels without much cause for alarm. “The situation could indeed cause inflationary pressure,” he says. “But that is not what is happening. Levels of capacity utilisation are very comfortable in almost all sectors and there are no real bottlenecks.”

It is widely acknowledged, however, that Brazil still faces obstacles to sustained growth. The stable currency, the de facto independence of the central bank and very favourable external circumstances governing trade and liquidity on financial markets have enabled Brazil to make great advances in terms of the quality of its economic fundamentals and its reduced vulnerability to external shocks. However, growth last year was just 2.3%, in line with the average for the past two decades.

To stimulate credit, investment and growth, Brazil needs to reduce the ratio of public debt to GDP, currently more than 50%, and address alarming fiscal imbalances, such as the bloated pensions system that is dangerously in deficit and eats up an extraordinary 42% of all federal government spending.

Mr Cypriano at Bradesco agrees that Brazil’s fiscal imbalances are “a constant worry”. But he points out that, even under low rates of growth, Brazil still offers room for dramatic expansion in banking. Last year, for example, Bradesco opened 800,000 new accounts.

Such rates of expansion are partly a reflection of the sheer size of the unbanked population in Brazil. About half the economically active population still has no access to banking services. But in Bradesco’s case it is also a consequence of the way the bank has repositioned itself over the past seven years, from being a ‘popular’ bank to one that offers services for almost all levels of the Brazilian market, including the Prime sector mentioned at the outset.

“We used to be seen as a popular bank. Now we’re seen as a complete bank,” Mr Cypriano says.

Segmentation of the bank began in 1999 with the creation of a new division, Corporate (using the English word). This caters to businesses with monthly income of more than 180,000 reais. In 2000, Bradesco launched its Private division, catering to wealthy individuals.

In 2001 came Banco Postal. This arrived as part of a wave of correspondent banking that took hold in Brazil at the start of the decade. Other similar ventures have run into trouble. Banco Popular do Brasil, for example, a subsidiary of the government-owned Banco do Brasil, has reported losses. Banco Postal is turning a profit, partly because it is a much simpler operation. Its outlets are in post offices. The service was put out to tender by the postal service and Bradesco bought the franchise for 201m reais in 2001.

Outlets offer simple banking services such as deposits, withdrawals, bill payment and small loans. Post office staff carry out all transactions and each outlet is linked to a nearby Bradesco branch that takes care of back-office operations. It is present in all but 200 of Brazil’s 5500 municipalities and, although margins are slim, it has recovered its investment and is turning a profit.

Bradesco’s next segmentation came in 2002 with Bradesco Empresas, for companies with a monthly income of 15,000 reais to 180,000 reais.

This was followed in 2003 by Prime, for wealthier customers, but not as wealthy as Private customers. A manager of Bradesco Private, for example, will deal with about 20 or 30 clients, compared with 70 at Bradesco Prime and about 200 in a normal branch.

The next stage will be to introduce Bradesco Pequenas Empresas, for small companies with income of less than 5000 reais a month. Such small businesses tend at present to get mixed in with personal customers but will be given their own platform inside normal Bradesco branches.

Customer poaching

The point of all this segregation, Mr Cypriano says, is to launch Bradesco into the next big phase in Brazilian banking: competition. Brazilian banks will say they compete heavily but, while mobile phone companies are constantly calling each others’ customers and trying to lure them away, it is almost unheard of for a customer of one bank to be approached by another in the same manner.

Defining clients more precisely should make them easier to target. But so far, not only for Bradesco, it has been more a question of preparing the ground than launching whole heartedly into the competitive fray. This tipping point has not quite been reached. But as base rates and, hopefully, lending rates fall further, and as credit expands to more appropriate levels, then banks will begin to feel the pressure of real competition.

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