Share the article
twitter-iconcopy-link-iconprint-icon
share-icon
AmericasJune 30 2022

Brazil's open banking, digital currency and ESG agenda

The strength of Brazil’s banks indicates that they will be able to stay the course as they navigate regulatory reforms and the emergence of new competitors. Lucien Chauvin reports
Share the article
twitter-iconcopy-link-iconprint-icon
share-icon
Brazil's open banking, digital currency and ESG agenda

Brazil’s banking sector continues to set the pace for Latin America, adopting new strategies to attract clients, addressing risks and meeting regulatory demands. Asset quality is good, with the country’s private banks exceeding earning expectations in the first quarter of 2022. Return on equity has rebounded strongly as the pandemic has receded, averaging 19% in the first quarter.

Growth in the industry this year and next is likely to be mix of corporate and retail lending, but with more products aimed at the retail space, particularly credit cards and consumer finance. Unlike other countries in the region, Brazilian corporates have broader access to capital markets to raise cash. “We have seen an improvement in earnings, with banks delivering a good product mix. Banks are adequately capitalised, loan loss reserves are strong and business volumes are good,” says Claudio Gallina, a senior director for Fitch Brazil.

While outperforming forecasts at the start of the year, banks face short-term pressures from the current economic and political climate. Medium-term challenges come from increased competition as the country forges ahead with its latest phases of ground-breaking digitalisation and open banking requirement, and regulations for environmental, social and governance (ESG) standards.

Brazilians will go to the polls in October to elect a new president, with right-wing populist president Jair Bolsonaro running for re-election against left-wing former president Luiz Inácio Lula da Silva, who is trying to make a comeback after 12 years.

The immediate concern for the rest of the year is the economic climate, which started to improve after the first quarter, but still could create headaches. Downside risks for the second half of 2022 and 2023 include higher interest rates and inflation, market volatility and a weaker market sentiment.

Inflation is expected to ease after reaching 12% in April, and unemployment that month was just 10.5% — the rate lowest in seven years. Salaries, however, have not recuperated from the pandemic. Average wages were down 7.9% in April compared to a year earlier. A result of higher inflation and lower wages has been a jump in debt. The central bank reported that outstanding debt averaged reached 53% of household income in 2021, the highest rates since 2005 and 12 points above the pre-pandemic level in 2019.

Mr Gallina notes that rising debts is a concern for the financial sector. He says that banks will have to navigate through uncertain market conditions while dealing with increasing levels of competition, especially with credit.

In addition, competition has been stiff and will increase. “The neobanks are competing with incumbent banks, offering an attractive list of services. I would say that the incumbent banks have reacted very well by increasing products and controlling expenses, but this might get more difficult going forward,” he says.

Digital leap

The rising level of competition is part of the central bank’s plan for the banking system, which is reaching new levels with its open banking legislation. The country has been moving toward an open banking system for many years, even though the central bank only published specific regulatory guidelines for the process in 2019.

Rubens Sardenberg, chief economist at the Brazilian Federation of Banks (Febraban), says that today’s robust banking ecosystem is rooted in the country’s historic battle against hyperinflation in the 1990s. Inflation reached 2489% in 1993 year-on-year, but has been single digits most years since 1995.

Brazilian banks began investing in technology years ago because they knew they would not survive without it

Rubens Sardenberg

“Brazilian banks began investing in technology years ago because they knew they would not survive without it. We had national networks of ATMs and digital payment systems long before other countries,” he explains. “Hyperinflation was the start of our very modern ecosystem.”

Gustavo Franco, a former Brazilian central bank governor and current teacher of economics at the Catholic University in Rio de Janeiro, says that a watershed moment in digital development for the banking industry came in 2013, with approval of the legislation for payment mechanisms. The legislation opened the way for a huge boom in payment platforms and other digital alternatives. “Many changes we see today started in 2013, when the law for payment methods was approved,” Mr Franco says. “It made banks more competitive. The big banks are just as solid and profitable today as they were in 2013, even though they face more competition.”

The 2013 law led to major growth in fintechs in Brazil, which numbered 771 in 2021, according to a 2022 publication by the Inter-American Development Bank (IADB). Brazil is home to 31% of fintech platforms in Latin America and the Caribbean. Fintech start-ups received more than $3bn in financing in 2021. Mr Sardenberg says that the legislative change, which was carefully guided by the central bank, created a strong payment system alongside the traditional banks. Fintechs, including Nubank, emerged and gained ground.

Another landmark was the central bank’s launch in November 2020 of a real-time payment system, PIX. By February 2022, PIX had enrolled 124 million Brazilians — roughly 67% of the adult population — according to a recent report from the Bank for International Settlements.

In its first 15 months of operation, PIX saw 12.4 billion transactions and had signed up 9.1 million companies. A separate report from the World Economic Forum (WEF) stated that more than 40 million people made their first-ever bank transfer using PIX, and the IADB claimed transactions topped $824bn by the end of 2021. In addition, 75% of the transactions were person-to-person, while the rest are person-to-business or business-to-person transactions. “PIX has shown how the creation of real-time payments infrastructure can be an important tool for central banks to foster financial inclusion in the region,” according to a May report from the WEF.

The combination of incumbent banks and fintechs has allowed for 88% of Brazil’s adult population to be “bankerised”, having have at least one product in the financial system. Leandro Vilain, director of innovation, products and services at Febraban, said he expects an even bigger jump in digital products, including PIX, as new technology is rolled out. “Digital penetration has been huge and it has developed despite some restrictions with infrastructure,” he says. “New 5G technology is now being deployed, which will increase even more the use of digital channels.”

Brazil awarded its first 5G spectrum contracts last November, securing around $8.5bn in investment commitments. The service will be rolled out gradually, with the first users going online this year. According to the plan, 5G service should be fully implemented by 2028.

Open banking

The different legislation and resulting products form part of a broader open banking strategy the central bank has been implementing. The final stages of the process should be completed by the end of this year.

The system in Brazil is similar to what was implemented in the EU and the UK, and is based on the premise that the information banks have on a customer belongs to the customer and not the bank. As a result, banks are required to share the information they have with other banks, non-financial institutions and fintechs if a customer consents to the information sharing.

Mr Gallina said that open banking will create both synergies and competition between banks and fintech start-ups. He said the process would generate better products and better rates for customers. “The goal of all of this is to offer more credit at lower costs. It is not to reduce the share of the incumbent banks, but provide cheaper products in the system. The steps taken so far have been very interesting and the regulations are very good in our view,” he says.

Mr Vilain said phase two of the implementation, which is the capacity to share personal customer information, has been completed and the system is fielding around 800 million application programming interface calls per month. He said the system in the UK receives around 950 million calls per month, but has been in place much longer. “I think the open banking process here is already a success, although we still have issues to fix, like data quality and the customer journey. The next phase will be even more complex, with technologic issues, like cryptography, that we will have to sort out,” he adds.

Febraban is also pleased that the central bank, after a long review process, has announced new rules for fintechs.

Enforcement of the new rules, which were presented in March after a two-year process, starts in January 2023 with the goal of reaching full implementation by 2025. Fintechs will be subjected to the same rules as traditional banks, but applications will be based on size and complexity. The change will affect big players, such as Nubank, more than smaller payment platforms.

In announcing the changes, the central bank said they were adopted as a result of “risks without proportional prudential requirements [because of] the fast growth and sophistication of the sector”.

Mr Franco agrees with the changes, given the growth and reach of fintechs in recent years. “A number I like to point out is that the market capital of Nubank ($52bn) is much higher than the market capital of Banco do Brasil ($21bn), which is the oldest bank in Brazil,” he notes.

Cryptocurrency and cyber crime

Another change on the way is Brazil’s digital currency, but it is not going to happen as early as expected. The central bank announced at the end of May that it would not start testing the digital real this year, but will wait until 2023. If the tests go as planned, the rollout will begin in 2024.

Even with the delay, Brazil could still become the first major economy in the region to have a digital currency. The digital real would be backed by the central bank and, unlike cryptocurrencies, would be fully convertible with physical money.

Mr Sardenberg says it is important to distinguish between a central bank digital currency and cryptocurrencies. “As an economist, I do not see cryptocurrencies as money, but as an investment — and more precisely, as a speculative investment,” he adds.

He explains that cryptocurrencies required regulations and information campaigns so that the public is aware that they are volatile. Like with other asset classes, he adds, it might be wise to have cryptocurrencies managed through brokerage houses.

A related issue is the possibility of cryptocurrencies being used in money laundering and other crimes. He says that Brazil, unlike some of the larger economies where these currencies are making inroads, has a large informal sector and untraceable currencies could feed into illicit activities.

Mr Franco says it is important for authorities to work on regulatory issues concerning security, as other countries are doing, but also consider the complexities of Brazil’s market. “A point that I think is not being discussed adequately is the informal economy and how [cryptocurrencies] could be used to make payments without an [audit] trail. This is something that authorities in this country need to take seriously,” he says.

The potential pitfalls with cryptocurrencies are part of a broader effort by banks to protect themselves and their customers from cyber risk. Mr Gallina says that cyber security is a new challenge that the entire system is taking very seriously. “This is an important concern for the whole Brazilian industry as digital penetration has accelerated. Banks have been investing and warning clients to be wary of attacks through phishing and other scams on social media,” he adds.

ESG policies

Bank also face new challenges applying ESG requirements. The rules, approved by the Brazilian Securities and Exchange Commission, are scheduled for full implementation at the start of 2023. The rules spell out the reporting requirements for the different ESG components and are in line with UN recommendations. The central bank has been working on a system to improve ESG disclosures by banks, including a centralised databank that banks can use for due diligence during a credit-approval process.

In the area of the environment, companies must spell out climate risks and management of greenhouse gas emissions, while the social component focuses heavily on the issue of diversity, including age, gender and race. For corporate governance, key provisions cover the issues of leadership and accountability, establishing reporting standards.

Renato Lulia, group head of investor relations and marketing intelligence at Itaú Unibanco, says Brazil’s regulation are based on the recommendation of the international Task Force on Climate-related Financial Disclosures (TCFD), which encourages organisations to gather and disclose information about the impact of climate change on their business. He adds that while Itaú Unibanco has just finished incorporating TCFD recommendations, it has been using ESG criteria in its due diligence processes since 2017.

“We have intensified our efforts to drive the transformation of our clients’ businesses by the offering of products that encourage a low-carbon economy,” he notes. Itaú Unibanco has provided approximately $35.4bn in ESG products since 2019 and Mr Lulia said the goal is to reach $83.4bn by 2025 in loans in areas ranging from affordable energy to waste management.

Mr Gallina believes that regulations would improve reporting and, in the long run, reduce risks. “The regulations should improve the banking system’s transparency of ESG-related risks for all market participants,” he adds.

Was this article helpful?

Thank you for your feedback!

Read more about:  Americas , Americas , Brazil