COUNTRY BRIEFINGFROM THE ECONOMIST INTELLIGENCE UNITRISK RATINGSCurrentCurrentPreviousPrevious
Note: E=most risky; 100=most risky.SUMMARYThe availability of investment finance has long been restricted by tight monetary policy and high lending rates. Nevertheless, the domestic capital markets are gradually deepening and competition between lenders is increasing. Even so, most local-currency loans are expensive and short-term. Subsidiaries of foreign multinational companies often rely on loans from headquarters or their foreign-based financing agents to support their local operations at lower costs. There are few restrictions on foreign firms gaining access to the Brazilian markets. The private banks are well managed, well capitalised and profitable, but heavily exposed to government paper. The equity and corporate bond markets have strengthened in the past five years and in the long term will offer alternative financing opportunities for local and foreign companies. For now, however, they remain small and relatively illiquid in comparison to major developed markets.SCENARIOSThe stockmarket becomes more volatile amid rising global financial turbulenceModerate likelihood; Low impact; Intensity =6Brazilian equities were hit by bouts of international equity market turbulence in 2007 and early 2008, but rebounded rapidly not least because of the heavy weight of mining and energy firms, which have been benefiting from commodity price trends. However, a major recent global stock sell-off took the Ibovespa main stock index to around 20% below its May 2008 peak by the second week of July and at the time of writing a major recovery did seem to be underway. Foreign involvement in the stockmarket is significant (around 30%) which exposes performance to possible further turbulence in the global financial markets. Recent positive performance in equities has been mainly sustained by domestic investors. However, the relative shallowness of Brazil's equity markets, allied to a series of other factors supporting the currency, restrict the impact of equity market turbulence on other financial variables and on households' finances. Moreover, with growth prospects solid (despite expectations of a deceleration in 2009) and recent upgrades to investment grade rating, Brazilian assets will remain among the most attractive of emerging markets, encouraging a broadening of investment sources that will over time contribute to greater stability.Banks curb lending to consumers because of rise in defaultsModerate likelihood; Moderate impact; Intensity =9Growth of consumer credit has shown little sign of decelerating in recent months, despite rising borrowing costs. This reflects the fact that supply of credit has been increasing as a growing number of banks compete to extend lending. However, banks are becoming less willing to extend unsecured consumer credit, which had been a significant driver of growth. This is because delinquency rates for this type of credit are relatively high, prompting many banks to conclude that such loans were largely being used by heavily indebted households to roll over existing borrowing. Banks are competing heavily for a share of the payroll-guaranteed segment of the consumer credit market, and secured credit is also likely to continue to grow strongly. Businesses focused on the local consumer market may find that the lending boom for the consumers at the lower end of the income scale may have ended, and purchasing power at lower income levels, which has grown rapidly in the past three years, becomes more strained.BACKGROUND(Updated: February 7th, 2008)Financial ServicesBrazil's banking sector is strong, diversified and, after many years of reforms, well regulated and supervised. In the mid-1990s the sectorâwhich had to adapt to the change from a hyperinflationary environment to one of price stabilityâwas supported by a government sponsored restructuring plan. High levels of capitalisation and holdings of government debt enabled banks to weather numerous crises since the 1990s, both domestic and regional. Some restrictions to foreign ownership remain, but presidential decrees have allowed foreign banks to operate in Brazil and acquire local institutions. At the end of 2006, the banking sector, including both public and private banks, had total assets of R1.9trn (US$875bn) and employed around 425,000 people. Average return on equity stood at almost 23% for the second consecutive year in 2006. Brazil's commercial banks, along with their much smaller Chilean counterparts, are now the most solid and profitable financial institutions in Latin AmericaA process of consolidation under way since 1994 took the total number of banks to 159 in 2006, (including 61 foreign-owned), down from 240 a decade earlier. Efficiency in the private banking sector has improved as a result of consolidation and investments in information technology (IT). The top ten banks account for close to 75% of total assets. Two of the country's three largest banks ranked by assets are owned by the federal governmentâBanco do Brasil and Caixa Economica Federal (CEF, the country's biggest mortgage financier). Domestic institutions, mainly Bradesco and Itau, are the ones that have carried out the most significant acquisitions in recent years. In contrast to trends in other Latin American countries, such as Argentina and Mexico, only three of Brazil's top ten private banks were foreign-owned at end-2006: ABN Amro Real (Netherlands), Santander Banespa (Spain) and HSBC (UK).Top ten banks
(ranked by assets; Mar 2007)
Â Total assets (R m)% of system assets(a)
Banco do Brasil321,89816.8
Caixa Economica Federal219,50511.4
ABN Amro Real129,7766.8
(a) % of the assets of
the 131 largest banks.
Source: Banco Central do Brasil.Credit activity has picked up in the past two years as average lending interest rates declined to a still high 37.4% per year on average in May 2007, a 6.4 percentage point reduction within 12 months. Business lending rates averaged a still high 24.3% in May 2007, albeit down from an average of 67% in 2003. Consumer credit, which accounts for one-third of the total, remains the principal driver of credit expansion but credit to industry, which accounts for 22% of the total, is becoming increasingly important. The slowdown in credit growth in 2007 has been milder than expected as competition among banks has increased. Consumer credit grew by 25% year on year in January-May, down from an average of 35% in the same period a year earlier. Corporate credit growth has gathered steam over the past 12 months, hovering around 22% per month in January-May, up from 9% at the start of 2006.A strong increase in real incomes and the introduction in 2004 of payroll loans (whereby instalments are deducted automatically from the customerâs pay cheque) that offer greater guarantees to lenders contributed to the strong expansion in consumer credit. Total banking credit to the private sector reached 31.3% of GDP in mid-2007, up from 28.4% in the year-earlier period, which is still relatively low by international standards but on a par with the rest of the region. Average loan maturities increased to 368 days for consumer credit and to 234 days for corporate loans in 2006, compared with 319 days and 218 days respectively in 2005.Credit risk is generally managed well. Although the ratio of non-performing loans (NPLs) to total loans is relatively high by international standardsâat 7.1% for households and 2.8% for the corporate sector in May 2007âit is mitigated by full provisioning. The overall high level of delinquency ratios for loans has contributed to keep spreads (the difference between the weighted average interest rates charged by banks and their cost of finance) at extremely high levels. Bank spreads stood at 26% in May 2007 (38% for households and 13% for to businesses), down from 28.6% in the year-earlier period, but their decline has been slower than that of the benchmark Selic rate. There are several factors keeping spreads high, including the country's brief track record of low inflation and currency stability; the still-large (although diminishing) public-sector borrowing requirement (PSBR); a high incidence of payment arrears or default, leading to high levels of credit risk; and a lack of competition in the financial services sector. In the past, high risks associated with outmoded bankruptcy legislation have also contributed, but a new Bankruptcy Law introduced in 2004 has brought some improvement.The stockmarket has enjoyed a substantial revival in recent years. Economic recoveryâespecially the stellar performance of the export-oriented companies that dominate the indexâhas encouraged domestic investment in the local securities market, as have the authorities' efforts to encourage a culture of equity financing through regulatory changes, including measures to protect the interests of minority shareholders. These factors have also encouraged foreign interest, which has been further spurred by abundant global liquidity and the elimination in 2005 of withholding tax on foreign investment in the stock market. Brazil's main stock exchange, the Bolsa de Valores de Sao Paulo (Bovespa), has attracted a growing number of IPOs.Bovespa is the largest stock exchange in Latin America in terms of market capitalisation, reaching a record level of US$723bn in 2006, up from US$482bn in 2005. Relative to GDP, stockmarket capitalisation has reached around 70% in July 2007, up from 53% in December 2005. Brazil's strengthened external position helped the market weather recent bouts of turbulence on international financial markets (in May 2006 and February 2007) relatively well. The Bovespa index broke successive records in the first half of 2007, as international credit rating agencies put Brazil at one notch below investment grade. On July 2nd, the Bovespa index reached 55,000 points for the first time.As a result of abundant liquidity in global stock markets and growing business confidence in the domestic economy, the number of IPOs rose from virtually nothing in 2002 and 2003, to seven in 2004, nine in 2005, 26 in 2006 and 30 in the first half of 2007. As a result, Bovespa has reversed a previous decline in the number of listed companies, which has reached more 419 in mid-2007 (the highest number since 2002). As one of the emerging markets to have been most favoured by the carry trade, Bovespa has attracted huge sums of yield-seeking international capital since 2004 and, as a result, may remain volatile in the long term. But this may be partly offset by the fact that the foreign investor base appears to have become more diverse. Net foreign investment at Bovespa was down to US$850m in 2006 from US$2.5bn in 2005, in spite of a greater participation in overall trading (mainly in IPOs). Foreign investors accounted for 35.5% of all investment in the local stockmarket in 2006, up from 32.8% in 2005.The largest locally listed Brazilian companies, such as Petrobras, Ambev (the world's largest brewer by volume after its 2003 merger with Belgium's Interbrew) and CVRD, the world's largest iron-mining company, have tapped international capital markets either by listing on the New York Stock Exchange (NYSE) or by issuing global bonds. In July 2007 Brazil had 37 companies listed on the NYSE. Brazil is the main Latin American issuer in the US, followed by Chile (17 companies), Mexico (16), and Argentina (12).There is a small market for corporate bonds and bills, although these tend to be instruments with short maturities. Finance raised through domestic bond issuance has developed in recent years, but the secondary market is still very limited and liquidity is low. Total private bonds issuance increased from R5.3bn (or 0.3% of GDP) in 2003 to R69.5bn (equivalent to a still low 3% of GDP) in 2006. The private pensions industry is currently small and dominated by provision to public-sector workers. Both pension funds and mutual funds tend to have high asset weightings in government debt rather than equities. In contrast to the equity market, the Brazilian options and futures marketâBolsa de Mercadorias e Futuros de Sao Paulo (BM&F)âhas flourished in country's uncertain economic environment. It ranks among the seven largest such markets worldwide in terms of trading volumes, specialising in currency and interest rate swaps. The government does not participate in the BM&F. Trading is dominated by banks and corporates.The insurance sector has experienced rapid change in recent years. Since 1996 foreign insurance companies have been allowed to enter the Brazilian market without the need for a presidential decree. A few of them have entered the country in joint ventures with domestic companies that belong to large financial groups. The sector accounts for around 40% of the Latin American market. Although the Brazilian market has remained underinsured by international standards, it is also expected to expand following the abolition of the monopoly of the Brazilian reinsurance institute (IRB Brasil Re) at end-2006.Foreign Reserves and the Exchange RateThe 1994 Real Plan, which employed the exchange rate as an anchor against inflation, proved effective in ending hyperinflation but led to the overvaluation of the currency, eroding competitiveness. The emerging markets crisis of 1997-98 undermined investor confidence in the Real, and pressures on the foreign-exchange market intensified towards the end of 1998, as foreign banks cut short-term credit lines. Within days of the start of Fernando Henrique Cardoso's second presidential term, in January 1999 the Banco Central do Brasil (BCB, the Central Bank) was forced to abandon the peg and float the Real. The currency immediately lost one-third of its value against the US dollar and threatened to weaken further, until a drastic tightening of monetary policy by the Central Bank stabilised the markets.Following a brief interlude of stability in 2000, the Real came under sustained pressure again in 2001 and in the run-up to the election in 2002. From a fall of almost as low as R4:US$1 during the 2002 electoral campaign, its lowest ebb since the introduction of the free-floating exchange-rate regime in January 1999, the Real has appreciated almost uninterruptedly. Despite a brief setback in May 2006, when turbulence in global financial markets triggered a 17% fall in the Real against the US dollar in the space of two weeks, the real (trade-weighted) exchange rate has appreciated by around 30% since the start of 2004. The Real remains susceptible to bouts of volatility arising from confidence shocks, but policy continuity and gradually improving debt ratios will reduce this vulnerability over time. Brazil's foreign-exchange reserves (excluding gold but including IMF financing) have risen from under US$40bn at the end of 2002 to just over US$147bn in June 2007 (more than double the amount registered in the year-earlier period and nearly four times total short-term debt).
Authoritative analysis and perspective for every segment of the payments industry
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