Brazil’s big banks have developed an extraordinary ability to thrive in almost any environment.
They have lived through inflation, government debt defaults and over half a dozen new currencies in the past 10 years. Even so, many international analysts and economists worried that January’s devaluation would devastate the country’s banks. After all, a brace of banks failed after the Real Plan stopped inflation in its tracks in 1994. A senior economist at the Inter-American Development Bank said weeks before the real crashed that in Brazil, “devaluation combined with fiscal adjustment is a catastrophe because it (would) cause the collapse of the entire financial system and especially of the productive sector where foreign debts (would) become unpayable.”Instead of collapsing, some of Brazil’s big banks actually raked in impressive first quarter profits that in some cases were greater than their earnings for all of 1998. Most bankers could see that devaluation was inevitable and hedged their positions accordingly. Banco Itaú, the second biggest bank by assets, posted a first quarter consolidated net profit of $402.4 million, compared with $156.1 million a year earlier. Although Banco Bradesco, Brazil’s biggest bank by assets, was not nearly so successful – its first quarter earnings of $136.2 million were 20% less in dollar terms than the same period last year – its financial health was scarcely affected by devaluation.Roberto Setúbal, president of Banco Itaú, says the first half results were good not simply because of the devaluation. “They were in addition to a good recurring result which, discounting the devaluation gave a return on equity of 21%, 17% more than last year,” he said. “We expect these good results to continue.”

Big War Chests
The success of Brazil’s big banks is built on a solid balance sheet. Brazil has some of the region’s most highly capitalized banks. Itaú had a tier-one capital ratio of 24%, which is more than double the minimum required for Brazilian banks under guidelines of the Bank for International Settlements. The assets of third-ranking Unibanco, often considered the weakest of Brazil’s big banks, rose a nominal 14% to $20.11 billion, just under half of which were loans and $6.9 billion consisted of highly liquid federal government securities. Unibanco is not alone in holding a substantial part of its assets in government paper. Decades of economic instability, inflation and high interest rates have made Brazilians and companies suspicious of credit. And banks are wary of lending to private sector borrowers when the national treasury has such a ravenous appetite for cash to cover its budget deficits. This year it must finance a deficit on the order of $65 billion and is raising most of the money on domestic capital markets.Other factors also have helped strengthen the country’s banking system. Four years ago the government began pushing through a $55 billion restructuring of the sector (see box) and the arrival of a new batch of foreign banks in recent years helped provide an injection of fresh capital and new links to international groups. In March 1997 Spain’s Banco Santander acquired Banco Geral do Comercio for $202.6 million. The most recent newcomer was ABN AMRO of the Netherlands, which in November paid $2.1 billion for control of Banco Real, the country’s fourth largest bank. Brazil’s bankers know that living through the crisis does not entitle them to rest on their laurels. Business exploded after the Real Plan, but lending and financial activity have since diminished. The banking industry is consolidating, and the new foreign entrants are beginning to make their presence felt. The result is a heightened competitive environment. Big banks are grabbing more market share from their smaller competitors, but profits are not what they used to be. At the same time, foreign banks are taking market share from the large Brazilian banks. Perhaps the weakest point is high operating costs. One leading financial analyst commented: “Brazilian banks have a lot to learn. Their costs are among the highest in Latin America.” In a recent report, Morgan Stanley Dean Witter commented that in spite of the growing presence of international banks, “the top-tier Brazilian banks have not yet experienced the onslaught of foreign competition that would force them to be leaner operators.”Brazil’s central bank is concerned that although it has slashed its selic reference rate to 19.5%, or under 10% in real terms, this easing has not worked its way through the financial system. The cost of money is still very high. In August, interest rates on working capital loans to big companies ranged between 21% and 49%. Small companies must pay between 23% and 58% a year. The average rate for personal overdrafts was a scorching 10.5% per month, or 231% a year.Itau’s Setúbal says that the volatility of Brazil’s economy inevitably increases risk and the cost of money. “Spreads vary according to risk. A multinational pays a spread of .5% but with higher risks, the spread has to rise significantly,” he said. Setúbal says the financial system is trapped in a vicious circle in which higher rates raise the risk of nonpayment, which further forces a rise in rates. Bankers say their costs are further inflated by high taxes and reserve requirements. However, Morgan Stanley Dean Witter said in May that “we believe that all Brazilian banks actively manage their tax liabilities.” It also said that in the first quarter, “Bradesco paid R$17.1 million in taxes, implying an effective rate of 5.7%, versus an expected 33%.” Bankers are probably on stronger ground when they complain about onerous reserve requirements. At present, they must hand over 75% of sight deposits to the central bank with no remuneration. Banks must also direct fixed percentages of their assets to high-risk farm and mortgage lending.

Room to Save
Still, Brazilian banks have made great strides in cutting costs, even though most are still less efficient than their peers in the region. Unibanco says its cost-revenue ratio fell to 51% in the first half from 61% last year thanks both to cost reductions and better results. Floris Deckers, who heads ABN AMRO’s operations in Latin America and the Caribbean, says Banco Real’s ratio stood at over 80% last year, before the acquisition, but has now fallen to 66%. Deckers says banks should still be able to wring considerable earnings through relatively simple methods. Reducing headcount and increasing information technology capacity is one approach, which he expects will allow an 8% staff cut at Banco Real. Improving service at banks with their long queues, internal bureaucracy and unreliable systems should also pay off. He says “service in Brazilian banks is the second most unpleasant thing, after going to the dentist. Brazil is not a service-oriented country.” Efficiency ratios are distorted by the wide range of non-banking services that banks are required to provide. Furthermore, infrastructure costs are high, since major banks strive to provide national service in a country the size of the continental US. Bradesco alone has 2,200 branches scattered throughout the country, all of them integrated into advanced telecommunications and real time data networks.Brazilian banks are in the middle of a difficult transition, made harder by turbulent economic conditions. Although fears that the January currency crisis would force the government to restructure its debt proved unfounded, the rapid growth of its domestic currency debt remains a matter of concern. Analysts warn that banks such as Bradesco could lose up to 34% of its equity in a government default.

Vying for Control
The process of consolidation and concentration in the financial services that began five years ago with the launch of the Real Plan has yet to run its course. In 1994, Brazil had 271 full service commercial, investment and development banks. Since then 48 have merged or been taken over by other banks. The central bank submitted three banks to a temporary special administration regime, placed one under official intervention and liquidated 31. Seven more went bankrupt. The pace of transition is likely to quicken next year with the expected privatization of Banespa, the state bank of São Paulo now controlled by the central bank. All three big banks have said they will bid for Banespa, the country’s fifth biggest bank in terms of assets. Some analysts expect various foreign banks to participate as well. Control of Banespa would enable Bradesco to defend its dominant position in the Brazilian banking system. Although Bradesco, with its $43.42 billion in first half assets, is the country’s biggest private banks, it is on the defensive. Itaú, although one-third smaller than Bradesco, is significantly more profitable, reflected by a market capitalization nearly 20% greater than Bradesco’s. For Itaú, acquiring Banespa would allow it to vault over its rival Bradesco and establish itself as the top bank. In recent years it has grown through a series of well-timed acquisitions. It has bought up Bemge and Banerj, the state banks of Minas Gerais and Rio de Janeiro, and rapidly integrated these banks into its operations.For Unibanco, acquiring Banespa could be a matter of life or death. One senior São Paulo rating analyst said, “Unibanco must buy Banespa or Unibanco itself will be bought up.” The bank has recently filled its war chest with $476 million in equity from a capital-raising exercise as part of its preparations for the Banespa auction. Some observers believe that federally owned Banco do Brasil, the country’s biggest bank, may also be forced to seek a change of ownership. Its capital ratios barely meet the minimum 11% mandated by the central bank. Paul Bydalek, president of Atlantic Rating, a Rio de Janeiro-based rating agency, says “Banco do Brasil has to be privatized in coming years. Otherwise, where will the money (to capitalize it) come from?” In 1996 it had to raise $4.39 billion in capital from a share offering, bought mostly by the employees’ pension fund Previ.Banco do Brasil is struggling to transform itself into a profit-oriented bank. However, its finances are still fragile. In July, Andrea Calabi, then the bank’s chairman, warned that the bank’s entire capital could be wiped out if the Senate approved a resolution curtailing federal refinancing of a substantial stock of virtually worthless local government securities held by Banco do Brasil. Bonds held by the bank that were issued by the bankrupt municipality of São Paulo were alone worth over $3.33 billion. ABN AMRO’s Deckers expects that over the medium to long term, perhaps only Bradesco, Itaú and a reformed Banco do Brasil can be confident of a leading role as independent banks in the Brazilian or regional markets. Few other Latin banks have the scale, access to capital or sophistication of these players to compete successfully with the global banks that are likely to dominate the future of banking. He believes that banks such as Unibanco or his own Banco Real are large enough to establish themselves as national players in the future. A tier of mainly regional foreign-owned banks such as HSBC, focused on southern Brazil, or BBV based in São Paulo, may have to decide whether to limit their ambitions to geographical or product-based niches or take the risk of committing more capital to Brazil to build themselves into national banks.

Bounced from the Scene
Meanwhile, similar competitive factors have taken their toll in a country that once boasted some of the finest locally owned investment banks in the developing world. Since 1997, nearly all these proud names have vanished from the scene, consumed by big global banks. First to go was Banco Garantia, the São Paulo-based house that sold out to Credit Suisse-First Boston in 1997, victim of the first wave of emerging market turbulence. Two years later, Banco Patrimonio sold out to Chase Manhattan after its joint venture with Salomon Brothers ended when the latter merged with Citicorp, which has a large operation in Brazil. Although Garantia no longer exists as an independent entity, its highly rated staff with expertise in research and corporate finance have mostly stayed on board and has transformed CSFB’s operations in Brazil and the region. And Garantia’s swashbuckling spirit still lives on. In July, Brazil’s biggest brewer Cia Cervejaria Brahma stunned the country with the announcement that it plans to merge with its old rival Cia Antarctica Paulista to form the world’s third-largest beer company in a transaction worth about $3.94 billion. Controlling shareholders of Brahma include GP Investments, a holding company owned by former bankers at Banco Garantia. Bozano, Simonsen is the last big name in Brazilian investment banking. It has survived because it is part of a wider conglomerate that owns shares in businesses as diverse as Embraer, the successful regional jet manufacturer, and shopping centers. Bozano has also diversified into commercial banking through its $239 million acquisition of state-owned Banco Meridional in 1997. Still, not all the independents have given up on investment banking in Brazil. There are numerous houses which have prospered through privatizations or the growth in asset management. The rise of Opportunity, a Rio de Janeiro-based fund management company and quasi-investment bank, is a case in point. In July, it bought a 10% stake in one of the four privatized telephone companies after failing to do so at the privatization auction a year earlier. And Aloysio Faria, the former owner of Banco Real who sold out to ABN AMRO, has set up his own investment bank, Banco Alfa.