As interest rates head downwards, Brazilian banks, heavily dependent on revenue from government debt held in their portfolio, face being forced to do what is normally expected of banks: lend money and increase fee income.
About one third of bank revenue last year came from government debt, according to analysis by ABM Consulting in Ribeirăo Preto in Săo Paulo state (see tables right).
It is even larger for publicly owned entities. In the case of Caixa Econômica Federal, the government-owned building society and Brazil’ssecond-largest bank, the revenue from government debt accounts for about 51% of revenue.
There is plenty of room to lend in Brazil where credit is only about 25% of gross domestic product, compared with figures of over 100% in Europe, 70% in Chile and 100% in South Korea.
Increased lending is important to aid economic growth under the government of President Luiz Inácio Lula da Silva. The economy shrank 0.2% last year, Lula’s first year as president. The administration is predicting economic growth of about 3.5% this year.
Another helping hand for the banks comes from selling banking services.
Rita Maria Gonçalves, a senior director for Fitch Atlantic Ratings in Rio de Janeiro, who is concerned about how banks will compensate for the expected drop in interest rates, notes that banks are already receiving more revenue from services.
Fee income
Large Brazilian banks have been rapidly raising fees, so successfully that some are more than covering personnel costs with fees, estimates Carlos Coradi, head of consultants Engenheiros Financeiros in Săo Paulo. Banco Itaú Holding Financeira’s fees covered 161% of personnel costs last year, up from 139% in 2002, the bank consultant says.
In the case of Banco Bradesco, Brazil’s largest non-government bank in terms of assets, the fee revenue covered 95% of personnel expenses last year, up from 91% in 2002, he says.
Fee income was evident when Banco Itaú, Brazil’s biggest bank by market value, reported its 2003 fourth-quarter results.
The bank had a 15% rise in all fees, including mutual fund management fees, to 5.12bn real ($1.8bn) last year. The fee revenue helped Itaú’s fourth-quarter net income rise 24% to a record 854m real from 689.4m real, the Săo Paulo-based bank said.
“We can do well under whatever scenario for Selic,” asserts Roberto Setubal, Itaú’s CEO.
Selic, as the benchmark target overnight interest rate set by the Brazilian central bank is known, is now 16.5%, down from 26.5% in June. Because of the country’s need to roll over most of its internal debt, Mr Setubal does not believe the base rate can fall below 14% by the year-end.
Brazil had to roll over 54% of the government’s domestic debt last year, raising the total to 913bn real, or 58% of gross domestic product, accordingto the central bank.
“Real interest rates after inflation cannot be lower than 8% a year,” estimates Mr Setubal.
That slow decrease should help cushion banks from the impact of lower interest rates.
Itaú plans to increase lending by 20% this year and form a consumer finance company to take advantage of a surge in demand for credit, Mr Setubal said.
But in practice Itaú has been lending less. Itau’s lending declined to 44.6bn real at the end of December from 45.4bn real at the end of 2002. Meanwhile, credit card transaction volume fell 14% in the fourth quarter to 130m real from the third quarter. The bank said the fall reflected in large part lower interest rates.
Economies of scale
Banco Bradesco’s Márcio Cypriano, the CEO of Brazil’s biggest non-government bank in terms of assets, says achieving scale is necessary to compete in a lower interest rate environment. To that end, Mr Cypriano has made 17 acquisitions since 1999, the year he became CEO.
Bradesco’s net income rose 2.4% to 715m real in the fourth quarter as the bank boosted revenue from fees, which rose 29% to 1.28bn real from 991m real in the same period a year earlier.
Mr Cypriano says he expects lending to increase 25% this year. Bradesco’s loans increased 3% in the fourth quarter to 54.3bn real from 52.78bn real.
This is in line with the lending plans of Banco do Brasil, Latin America’s and Brazil’s largest commercial bank in terms of assets, which expects its lending to increase between 20% and 30% this year, mostly to small and medium-sized firms.
The base interest rate of 16.5% gives the country the highest cost of money in the world for banks, ABM Consulting estimates. This is because of the compulsory deposits banks must make at the central bank, the taxes and the weak bankruptcy laws, says Mr Setubal.
Brazil also does not have a nationwide system of credit bureaux or credit-reporting agencies such as exist in the US. Therefore banks factor in higher interest rates to cover the cost of bad debts.
Meanwhile, mortgage lending is limited in Brazil, in part because of the weak bankruptcy laws, but this may change.
“The new bankruptcy law is very important to reduce spreads on loans,” say bankers, referring to legislation being debated in the capital Brasília.
Brazilian banks will make the transition to a lower interest rate environment. Some of them, like Bradesco and Itaú, made the adjustment when the anti-inflation Real Plan went into effect by increasing fees. This is the current strategy. Straightforward lending may be another matter, although some newcomers are venturing in (see article Banking for the bankless).
Overall, though, gathering revenue will be a much harder slog.
