Fitch Ratings released a report on the recent acquisitions of small banks by Brazilian non-bank financial institutions (NBFI), which is expected to help diversify their funding, increase earnings and improve transparency.
BNamericas spoke with Fitch Ratings' head of financial institutions, Claudio Gallina, about why NBFIs have started to show interest in these acquisitions, what types of risks they'll face and how it will affect the financial system.
Brazil has faced a strong recession with GDP contracting more than 7% in the past two years and some institutions decided to leave the country. In addition to the increased risk in Brazil, due to still high unemployment, difficult cash flow generation from companies and a consequent strong increase in [non-performing loans] NPLs, and reduced profitability for banks, some international institutions also decided to reduce their international presence because of other issues, including higher global regulatory requirements, low global growth, new political risks rising in key regions, and negative or very low interest rates in some developed economies. This is from the supply side. On the demand side, we know that larger banks
– like Itaú
– already have in place a robust product distribution capacity, strong business profiles and product diversification, which may not justify acquiring new local small/midsize banks.
The prices of these institutions, we suspect, are now more attractive to NBFIs that can, firstly, increase and diversify their funding base given that NBFIs in Brazil are limited in terms of funding products, and also increase their client base and credit portfolio.
BNamericas: What type of risks are they facing by making these investments?
Gallina: There are several risks involved. First, operational risk – in the case the new institution decides to expand its operations aggressively, most probably new investments in technology and risk controls will be needed. The question is: Will these institutions have the resources to do it? There is an important learning curve when buying an institution, even for large players. Other risks are merging cultures and staff, and also, if the recession lasts longer than expected. Depending on the calculation made when acquiring the bank, looking at risk versus return and, the timeframe of the expected return, the NBFI may be required to inject more capital into the bank to maintain its activities.
BNamericas: Will there be any regulatory issues?
Gallina: Most of these NBFIs already follow strict regulatory requirements and they already generate reports and data to regulators similarly to banks, so we don't expect any regulatory problems.
BNamerias: How and when will this trend affect the credit market?
Like several other Latin American economies, the Brazilian credit market is very concentrated. The 10 largest banks represent more than 85% of the system's total assets. We don't believe that this trend will significantly change the dynamics nor the structure of the Brazilian credit market in the short or medium-term. We also believe that in the long-term a lower key interest rate in Brazil may have a stronger effect on retail credit than the acquisitions by the NBFIs.
BNamericas: How can these bank purchases benefit the NBFIs in concrete terms?
Gallina: While we are not expecting any significant effect within the system, we believe that the acquisitions may help NBFIs expand their operations by product and geography, as well as their cross selling and earnings in the medium to the long-term.
BNamericas: You say in your report that the acquisitions have not yet affected the ratings of the NBFIs. What more would need to happen for ratings to be changed?
Gallina: It will be on a case by case basis. It depends on how the acquisition will be managed, synergies arising from existing operations, the need to invest in controls, costs, knowledge of the acquired business, management expertise, cultural adaptation and other factors. It depends on how fast the NBFIs will be able to deal with all of these factors. And, of course, it will also depend on the evolution of the domestic operating environment – in particular the recovery of GDP and employment – since the development of the NBFIs and small and mid-size banks is strongly dependent on the macro scenario.