Brazil Banking Report
Risks to the performance of Brazil's banking industry increased in the second quarter due to poor economic activity and some political noise.
At the start of the year, the biggest banks were expected to generate high profits this year due to the likelihood of faster loan growth, with private sector players leading the charge.
Back then Latin America's largest economy was widely expected to stage a major comeback this year due to the coming to power in January of business-friendly President Jair Bolsonaro. So far, however, the economic performance under the business-friendly leader has been a big disappointment.
“As banks are seeing that the economic activity is weak, they will concentrate their lending activities in areas with lower default risk, such as payroll linked loans, mortgages, among others,” Luis Miguel Santacreu, a banking analyst at local rating agency Austin Ratings, told BNamericas.
Banks could still come through 2019 with attractive profits since a more conservative approach to lending will reduce the need for loan loss provisions, added Santacreu.
The five largest lenders, private banks Itaú Unibanco, Bradesco, Santander Brasil, and state-run Banco do Brasil and Caixa Econômica Federal, posted a combined net profit of 23.6bn reais (US$7.02bn) in the first quarter, up 27.4% from the year-ago period, according to central bank figures.
Earnings generation in the first quarter was mainly driven by stronger loan growth as the outlook for the economy was then much better.
Lending in the financial system grew 5.4% in the 12 months through April, according to the latest figures from the central bank. Loans to individuals and companies increased by 9.5% and 0.6%, respectively.
ECONOMIC GLOOM
Brazil is suffering from major headwinds on the economic front.
GDP contracted 0.2% in Q1 from the fourth quarter of 2018.
It was the first time the economy contracted since the last quarter of 2016, when the country was emerging from a two-year recession.
The negative result was driven by the agriculture and industrial sectors, which shrank by 0.5% and 0.7%, respectively.
More worrisome is the contraction of investments as measured by gross formation of fixed capital, which declined 1.7%. This is considered a key barometer of the future performance of the economy, as it tracks corporate investments in machinery.
The poor Q1 performance confirms that Bolsonaro has failed to revive the weak economy, which was one of his main promises in last year's election campaign.
Brazilian economists surveyed weekly by the central bank have gradually reduced their 2019 growth forecast since Bolsonaro took office.
After expanding by a disappointing 1.1% in 2018, the economy is projected to grow less than 1% this year, according to the latest central bank survey.
Earlier this year, Bolsonaro’s administration presented a pension reform proposal, with various unpopular measures, including minimum retirement ages for men and women, and increases in contributions paid by both private and public sector workers.
The reform targets fiscal savings of 1.2tn reais (US$307bn) over the next decade. However, the inability of the government to arrange political support may cut deep into the projected savings.
Getting the reform approved requires constitutional changes, which 308 of the 513 lawmakers in the lower house need to back. In the senate, the reform requires a two-thirds majority.
“The most likely scenario is for the pension reform proposal to suffer a series of changes to be imposed by the congress, before approval. After that, savings will be between 500bn and 600bn reais,” said Jose Carlos Faria, chief economist at BNP Paribas in Latin America.
The sponsor of the pension reform proposal suggested recently that taxes could be raised on banks in order to compensate for the lower-than-expected savings that the reform is likely to generate - due to political concessions to get it approved.
Lawmaker Samuel Moreira of the PSDB party suggests hiking the social contribution rate on net profits to 20% from 15%.
Such an increase would create additional tax income of 50bn reais in the next 10 years, according to Moreira.
When running for president last year Bolsonaro praised the significant corporate tax rate reduction that was implemented in the US by President Donald Trump - and promised something similar if elected. Tax experts expect Bolsonaro to honor his campaign pledge, but only after the pension reform issue has been settled.
THE BNDES "AFFAIR"
Elected with promises to wage war against corruption and political influence at state-run firms, Bolsonaro has now taken action that appears to be contrary to those pledges.
Earlier this week, the government named Gustavo Montezano as new president of development bank BNDES. A former investment banker, Montezano will replace Joaquim Levy, who recently resigned from his post due to a public disagreement with Bolsonaro over a high-level appointment at BNDES.
The far-right Bolsonaro had threatened to fire Levy if he did not fire a newly hired director with links to the leftist workers party (PT).
According to local media, Montezano is a friend of senator Flávio Bolsonaro, one of the sons of the Brazilian leader.
Levy had been picked as BNDES head by economy minister Paulo Guedes as part of pledges to only use technical criteria when appointing high-level executives at state-owned companies and banks.
Santacreu at Austin Ratings said that all signs now point to a weak BNDES under Bolsonaro, and although this could provide an opportunity for commercial banks to gain project finance market share, it could be negative for the financing of much-needed infrastructure projects due to BNDES' strong expertise in that area.
THE FINTECH SCENE
The government is engaged in expanding competition in the banking industry by easing the access for new entrants.
Earlier this month, the government together with the central bank and the insurance regulator, announced an initiative to establish a regulatory sandbox for fintech and insurtech development.
“This initiative comes as a response to the transformation that has been taking place in the financial, capital markets and insurance segments,” said economy minister Paulo Guedes.
With a sandbox, the central bank and the insurance regulator can develop initiatives to smooth the market entry of new companies.
The government sees the surge of fintechs and insurtechs as a way to reduce high concentration in Brazil's banking and insurance markets.
At the end of 2018, the five largest banks commanded around 81% of total financial system assets and nearly 85% of all loans.
Insurers owned by the same banks also dominate in several insurance segments.
According to a study by Fintechlab, which was commissioned by the economy ministry, 331 fintechs operate in Brazil.
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