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AmericasJuly 8 2020

Brazil’s banks brace for impact as crisis deepens

With record deaths from Covid-19, a likely recession and an unpopular president, Brazil’s future looks volatile. And its banks, though well capitalised, are likely to struggle.
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Brazil is collecting unwanted records. In the third week of June 2020, it became the second country in the world to report 1 million cases of coronavirus infections and the second with the highest number of Covid-19-related deaths after the US, according to John Hopkins University School of Medicine. Worse, analysts believe these figures are an underestimate.

They also expect Brazil to plunge in a dire recession that would range from a 4.5% gross domestic product (GDP) contraction in 2020, according to Itaú Unibanco, to an 8% contraction, according to Bank of America. “There’s only downside risk,” says Claudio Irigoyen, head of Latin America research at Bank of America. Referring to the 2 percentage points on each side of the economic prediction, he says: “It’s more likely that it will be [a recession of] 10% rather than 6% in 2020.”

The rest of Latin America is on a similar trajectory. “This is pretty unprecedented,” says Mario Mesquita, chief economist at Itaú Unibanco, Brazil’s and Latin America’s largest lender. “Even during the 1980s [debt] crisis, there was always a country that managed to grow. Now all countries are in recession.” 

Lockdown less effective

Many have explained the failure of lockdowns to contain the spread of the virus with the high level of informality across Latin America. Although not one of the worst in the region, Brazil’s number of unregulated jobs represents 41.4% of the total, according to figures released by the government statistics agency IBGE at the end of October 2019.

“Particularly for Brazil, but it can be generalised across Latin America, lockdowns have not been effective in containing the virus but have caused big economic damage,” notes Ernesto Revilla, head of Latam economics at Citi, which predicts a 6.5% contraction in GDP in 2020.

Delayed or unhelpful messages from heads of state have also been singled out as a negative contributing factor in some countries. In Brazil, for example, president Jair Bolsonaro suggested that the implications of Covid-19 for an otherwise healthy person would be similar to those of a little cold, a resfriadinho. A study by Cambridge University and the São Paulo School of Economics-FGV found that Mr Bolsonaro’s televised dismissals of measures – such as quarantine or school closures introduced by state governors, as well as recommendations by his health ministry and the World Health Organisation – led to millions of Brazilians ignoring social distancing rules. By the middle of May, the Brazilian government had lost its second health minister in less than a month following disagreements with, and public criticism from, Mr Bolsonaro.

Analysts note that the diverging views of the president and the state governors complicate things further. It is governors and mayors who decide on restrictions across Brazil’s 26 states; Mr Bolsonaro would like lockdowns to ease earlier than many local administrations are prepared to allow. 

In a research note, Capital Economics says that while it expects that the virus will eventually come under control, “the evidence suggests that this will happen more slowly than elsewhere. Correspondingly, social distancing measures will stay in place for longer and the economic recovery will be slower.”

Like Bank of America, Capital Economics expects Brazil to have an 8% GDP contraction this year. It also believes that the handling of the pandemic has “severely damaged the government’s popularity” and is contributing to a potential political crisis.

Brazil charts 1

Outlook for banks

How does this affect banks? As with any fall in economic or financial activity, they will suffer, but there are a few things to alleviate the situation. Brazil’s largest banks are well capitalised. Further, the growth of capital markets activity at the expense of bank finance in 2019 may now play in lenders’ favour. 

Share offerings more than tripled to $28bn in 2019, according to data by Refinitiv. This was helped by interest rates being at record lows, making corporate issuances, equity issuance in particular, rather than government debt, more appealing. The benchmark interest rate Selic was 4.5% by the end of 2019 and has since dropped further to reach 2.25% on June 18. 

Meanwhile, loan portfolios at some of Brazil’s largest banks barely moved in 2019. Itaú Unibanco and Banco Bradesco grew their total gross loans by 5% and 7%, respectively, while Banco do Brasil’s figure shrank by 6%, according to The Banker Database.

“The fact that we didn’t have a credit boom before Covid-19 is an advantage now,” says Mr Mesquita. Looking at corporate clients, the “major increase in capital market activity [last year], which at the time was hurting banks revenues, now works in banks’ favour”, he adds.

But Mr Revilla points to the fact that, while a useful attempt to boost the economy, declining interest rates erode banks’ interest rate margins.

Well capitalised

On their side, banks have relatively high capital levels, with 14.4%, 13.3%, 13.55% Tier 1 capital adequacy ratios, according to Basel III standards, for Itaú, Bradesco and Banco do Brasil, respectively. So far, bad loans have not risen dramatically either, note analysts. “Brazilian banks have sizeable capital buffers,” says Mr Mesquita.

Bank of America’s Mr Irigoyen says: “We haven’t seen a lot of non-performing loans and delinquencies yet, but it’s a bit early. Banks are well capitalised – we don’t expect them to go under but they’ll suffer.”

The year began with high expectations on the equity capital markets also riding on the success of the government to push through a long-waited pension reform. Confidence grew about the chances of other reforms planned by finance minister Paulo Guedes for this year, including the simplification of Brazil’s cumbersome and bureaucratically expensive tax code.

The pandemic has stalled the reforms agenda, however. Capital Economics warns in its research note that the government’s lower popularity, because of its handling of the pandemic, will not help bring it back to life.

“There was huge optimism before the [Covid-19] crisis [around the] reforms, [and] huge expectations about initial public offerings,” says Mr Irigoyen. “Part of it might come back. Companies opportunistically might try to issue [equity] or go public but, generally, they are the [big] losers [in the current situation].”

Restarting the economy will be tough. As with the other countries affected around the world, travel, entertainment and hospitality are among the hardest hit sectors. In Brazil, the reopening of business has not been uniform across the country.

The city of São Paulo has been at the epicentre of the pandemic. Although the death toll continues to rise and its health system is on the brink of collapse, according to reports, the city began to reopen its shopping malls and other businesses in mid-June. Employers, including banks, are planning how to allow staff back to their offices (bank branches have remained generally open, notes Mr Mesquita). 

Permanent change

Itaú Unibanco’s Mr Mesquita moved with his family to Ibiuna, a town outside São Paulo city where he has a weekend property, at the end of March, as did some of his peers. “I see many from the market when I go to buy food,” he told The Banker in early June, as he was preparing to return to São Paulo. “We are definitely not going to rush to go back to the office.” 

He adds that many corporate functions have adapted to a new way of working, which will continue for some time. Echoing what others believe across the world, he says that, for example, “corporate travel is unlikely to recover anytime soon because the corporate sector has learned that many face-to-face meetings can be done effectively on a screen and that changes things for good; it’s a permanent change”.

For non-office jobs, particularly for informal jobs, finding an alternative to personal interactions is much harder, if not impossible. If economists are taking on the task of calculating the implications of protracted lockdowns on the economy, few are attempting to model the likelihood of a second wave of contagion, notes Mr Revilla. “We still don’t know how the virus works; are people [actually] immune once they catch it?” he says. Without a second wave, Citi predicts a 4% economic rebound for Brazil in 2021.

But Mr Irigoyen warns about the dangers of relaxing the lockdown too early. Allowing people to move freely, only to then take back that freedom because of a spike in contagions and deaths will cause “riots in the street”, he says. But, he adds: “If the economy doesn't pick up, you will still have riots in the street.”

Brazil charts 2

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Read more about:  Americas , Americas , Brazil
Silvia Pavoni is editor in chief of The Banker. Silvia also serves as an advisory board member for the Women of the Future Programme and for the European Risk Management Council, and is part of the London council of non-profit WILL, Women in Leadership in Latin America. In 2019, she was awarded an honorary fellowship by City University of London.
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