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Banks in Brazil will be forced to focus on high risk areas to maintain profitability levels next year to compensate for the drastic reduction in interest rates.
After years of adopting a conservative approach to protect their balance sheets from non-performing loans amid a deep economic recession, the strategy is no longer considered sufficient to guarantee positive results.
"Banks will be obligated to assume more risks to arrange higher returns and will turn their focus to loans for individuals, such as financing of vehicles, along with small companies. Both categories present more risks of default, but offer much more returns," said João Augusto Frota Salles, a banking analyst at local consultancy group Lopes Filho, in an interview with BNamericas.
"Banks were able to maintain their profitability in recent years, even with low demand for new loans, as the interest rates were high and provided a comfortable return for financial institutions," he added.
With the benchmark Selic interest rate in double digits until this year, banks put most of their money in government bonds and adopted a conservative approach to new loans, and as a result were able to post high profitability.
In recent months, the central bank has cut the Selic rate aggressively, as inflation is below the monetary authority's target. The central bank has cut the Selic by 625 basis points so far this year to 7.50%.
The rate is expected to be reduced to 7% in the policy committee's next meeting on December 6 and remain at that level through 2018, according to economists.
"In the next year, we'll look for areas where we can arrange a higher margin, for sure, such as personal loans, and financing of working capital for medium and small companies," said Paulo Caffarelli, president of state-run Banco do Brasil, after being questioned by BNamericas during a conference.
"It's also important to highlight that this strategy, combined with the strict control of our expenses, will be important to increase our profitability."
Caffarelli said he expects an expansion of 6% in new lending in the financial system next year, compared with flat growth this year.
Brazil's major private sector banks, such as Bradesco and Itaú Unibanco, which historically have been more conservative than their state-run peers, will likely assume a similar strategy to boost returns.
"After years of contraction of new credit in our vehicle financing area, we're prepared to resume such loans," said Itaú president Candido Bracher in a recent conference call with reporters.
Brazil has been in recession for the last two years, contracting 3.5% in 2015 and 3.6% in 2016, but this year is gradually recovering.
Tepid economic growth has provided no appetite for new loans so far, but with the reduction in provisions charges, due to lower non-performing loan rates, banks are expected to post healthy profits this year.
Major listed banks Banco do Brasil, Itaú, Bradesco and Santander Brasil posted combined earnings of 16.4bn reais (US$5.02bn) in the third quarter, up nearly 15% from a year earlier.