Press Release

Fitch estimates limited impact on Brazilian banks due to election results

Bnamericas Published: Friday, November 18, 2022

This is a machine translation of Fitch's press release, originally in Portuguese

Fri 18 Nov, 2022

Fitch Ratings-Sao Paulo/NY/Rio de Janeiro-18 November 2022: It seems unlikely that the re-election of leftist candidate Luiz Inacio Lula da Silva as president of Brazil will result in major changes in macroeconomic policy, although some changes in microeconomic policies are expected , which may affect Brazilian banks. However, the president-elect has yet to define his economic team, resulting in some uncertainty regarding the predictability of the policies to be adopted. Lula will assume the Presidency on January 1, 2023.

The Operating Environment is the main anchor factor for the ratings of all banks, whose ratings are based on their intrinsic credit quality, reflected in their Viability Rating (VR). The sovereign rating ('BB-') influences the Operating Environment score, but can also be adjusted by factors relevant to Brazil, such as: institution size, structure, stability and performance of the economy, credit level and growth, development of the financial market, regulation and legal framework, as well as expectations for general credit indicators. However, state-owned banks will be closely monitored, as these entities are likely to face the most immediate impact of the change in government. Federal bank ratings are support-based and therefore linked to the sovereign's creditworthiness. The agency will continue to assess the government's ability and propensity to support state-owned banks.

One of the main points to be monitored will be the evolution of the financial profiles of state-owned banks. Private banks' share of domestic lending increased to 57.6% in the second half of 2022 from 53.2% in June 2020, while federal banks' market share fell to 42% from 46% in the same period. This indicates that left-wing governments may further encourage public banks to develop a stronger appetite for credit than private banks in certain periods, although it is still too early to say that this will happen. A possible change in the competitive scenario may affect private banks, especially smaller institutions, which may suffer from a reduction in market share and a possible increase in funding costs.

Public banks have specific strategies and, like private banks, follow the policies and guidelines provided by the controller. Historically, such strategic guidelines have been revised due to changes in government. The State-owned Law (from 2016) and the independence of the Central Bank (conquered during the current president's term) may, to some extent, limit changes in terms of administration (and, consequently, changes in strategies) of public banks. The independence of the Central Bank will be tested in the new government, according to its current president, Roberto Campos Neto, and indicates that the regulatory environment may suffer less influence to make more flexible/dismiss regulatory guidelines, due to a possible change in government.

Fitch will closely monitor the risk of changes in the newly strengthened strategies of state-owned banks that could negatively affect these banks' financial metrics, particularly asset quality, profitability and capitalization. The government's current repositioning strategy for some state-owned banks, which reduced their lending capacity, due to the prepayment agreement for hybrid instruments to their controller (the government), drove the fall in the participation of federal banks in the credit market. credit since 2016, when the left-wing party ended its mandate. In Fitch's view, sudden and significant increases in the volume of credit operations are usually followed by an increase in credit-related problems. High inflation and rising household debt are the main sources of pressure on asset quality so far. In profit-loss (P&L) terms, cost management will also be key.

In Fitch's opinion, although the current levels of reserve coverage offer sufficient protection for the expected increase in credit losses, and the credit policies of public banks have been gradually strengthened — something that became clearer after Operation Lava Jato in 2014 — the risks of government interference in the operations of these banks remain. However, the current default levels of public banks (mainly BNDES, Caixa and Banco do Brasil) indicate that good practices have been followed in recent years.

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