BRIC Spotlight

Brazil Banking:
             Retail Segment Driving Growth

Looking back, it appears that the recession not just showcased the resilience of Brazilian banks but also directed them, ironically, to bigger revenues. Consumer credit had been expanding fairly rapidly in Brazil even before the downturn. When the economy started contracting at the height of the recession, the Lula government began fostering credit growth aggressively. Further, after staying in an uptrend briefly between April 2008 and December 2008, interest rates too started declining as economic activity slowed and inflation moderated. For the major part of its economic history since World War II, Brazil has had a high-interest-rate environment due to its experiences with hyperinflation and other financial problems. Therefore, Brazilians, who had seen interest rate levels in the range of 24%-26% as recently as mid-2003, were likely pleasantly surprised to see their central bank’s benchmark SELIC rate progressively plunging to as low as 8.65% by mid-2009.

In a happy coincidence, it was around this time that after five years of uninterrupted rapid economic growth between 2003 and 2008, the average Brazilian had begun to feel more confident about his job and future, and therefore more inclined to borrow and spend on everything from cars, apartments, mobile phones, and household appliances to beauty treatments. It is no wonder then that in early 2009, Brazil entered a new era of credit-led growth, which has since led to a massive surge in the demand for loans, financial products, and nearly everything that is a source of revenue for banks.

Industry Players

Among the top ten Brazilian banks in terms of total assets, three are government-owned (Banco do Brasil, Caixa Economica Federal or CEF, and the country’s development bank BNDES); five are domestic non-government owned (Bradesco, Itau-Unibanco, Banco Santander Brasil, Safra, and Votorantim); and two are foreign (HSBC and Citibank). The top four publicly listed banks are Banco do Brasil, Itau-Unibanco, Bradesco, and Banco Santander Brasil.

• Banco do Brasil, majority-owned by the Brazilian government and listed on the São Paulo Stock Exchange, provides a wide range of financial products and services, such as deposits, saving accounts, credit cards, asset management, loans, foreign exchange, as well as health, life, and property insurance. Aiming to control a large part of the U.S. remittance market, Banco do Brasil recently launched a subsidiary, BB Money Transfers. Banco do Brasil is believed to be Brazil's oldest active bank and one of the world's oldest financial institutions. Since it is government-controlled, the bank has advantages as well as disadvantages. While it has the mandate to recruit employees only through a public draft process, which may not yield the best candidates, the bank benefits from being the “banker of choice” for several state and municipal governments.
  
  
• Itau-Unibanco: In 2008, Banco Itaú merged with Unibanco as part of a $12.5-billion deal to create the country's largest non-government-owned bank. Itau-Unibanco, listed on both the NYSE and the São Paulo Stock Exchange, is active in all areas of domestic economic activities and controls an estimated 11% of the Brazilian retail banking services market. In a significant move in 2009, the bank merged its automobile and residential insurance business with the country’s largest auto insurer Porto Seguro. The deal gave Porto Seguro access to more than 50 million clients at Itau-Unibanco and provided the bank a footprint in a new area.
  
  
• Banco Bradesco, listed on the NYSE as well as the São Paulo Stock Exchange, has followed an acquisitions-led growth strategy. In 2009, the bank snapped up Banco Ibi, one of Brazil’s top five branded credit card issuers, for around $720 million. At the time of its acquisition, Banco Ibi was the consumer finance arm of C&A, one of Brazil’s largest clothing retailers. Although Banco Ibi also offered insurance, personal loans, and savings accounts, the fact that it was the exclusive provider of credit for C&A customer purchases was its biggest attraction. Bradesco itself is a large card issuer in Brazil and it has business agreements with several retailers. Also, Bradesco is Brazil's largest insurer and has a huge business in life and health insurance. The bank's insurance and retirement business accounts for about a third of its profits.
  
  
• Banco Santander Brasil, listed on the NYSE as well as the São Paulo Stock Exchange, is the subsidiary of Spanish banking group Banco Santander. It operates in all banking segments.
  
  
• Caixa Economica Federal or CEF is government-run and Brazil’s biggest housing lender. The unlisted bank primarily acts as a medium for public investment. Since the global financial crisis, it has diversified into the corporate and consumer loan segments as well. CEF also manages most Brazilian lotteries.
  
  

Industry Growth Factors

Brazil’s banking industry has been and will likely continue to be driven by economic growth in several ways. Since 2003, more than 8 million jobs have been created and the unemployment rate has fallen from 12.1% to 6.5%. At the same time, the federal administration has hiked minimum wages a number of times and pushed them up more than 45%. Further, innovative government programs such as the Bolsa Familia*— a social welfare program that provides financial help to poor families — have freed nearly 30 million Brazilians from abject poverty. With this, the middle class, the mainstay of domestic consumption, has expanded to make up more than half of Brazil’s population today. Also, a new section of borrowers — the lower-middle and working classes — has become creditworthy from the banks’ standpoint due not only to higher incomes but also a series of timely systemic changes. For instance, bankruptcy proceedings and asset recovery in Brazil have recently become considerably easier and quicker to resolve.

Brazilian banks have responded to these socio-economic changes by expanding their loan portfolios aggressively. In fact, central bank data indicate that total credit in Brazil’s economy, comprising credit to both individuals and industry, has grown from 35.2% of GDP in 2007 to 46.4% of GDP, as of March 2011. And, according to the IMF, private credit in the country, comprising loans to consumers for buying cars and household appliances, among other things, has soared around 100% since 2007.

The banking segment that has benefited the most from this trend is mortgage lending, which saw 58% growth in 2010 and is projected to increase around 30% in 2011, a Reuters news report says. Curiously, though, this business is still in a nascent stage in Brazil as the total stock of mortgages in the country is just 4% of GDP, as of March 2011. In fact, mortgages were a little more than 2% of GDP in 2009, but the segment has grown rapidly on the back of a housing boom in the country. Since Brazil has an estimated deficit of 6-8 million housing units, more than 90% of it in the low-income space, the mortgage lending segment is expected to record steady growth over the long term. The Minha Casa, Minha Vida (My House, My Life) affordable housing program, which the government launched in early 2009 to provide subsidized housing to a wide section of Brazilians, has also provided a fillip to the segment.

It is not just loans though. Typically, Brazilian banks, especially the larger ones, operate not only as traditional lending institutions but also as providers of financial products and services such as insurance. For example, one of the top two non-government-owned banks, Bradesco, is also Brazil’s largest insurer, and Itau-Unibanco, the largest non-government-owned bank, has an auto insurance business. Therefore, Brazilian banks have been ratcheting up their presence in as many retail segments as possible, depending on the scale of their operations and asset base, in order to capitalize on rising income levels and the growing demand for other financial products. Some of these segments are:

• Insurance, which is reasonably well-evolved in Brazil, comprising sub-segments such as auto and health insurance.
  
  
• Payroll lending: This is a fairly new loan market where lenders collect repayments directly from the payrolls of borrowers. Payroll lending is primarily directed at low-income borrowers. Banco do Brasil has been expanding its payroll lending portfolio, which now accounts for more than a third of its personal loans.
  
  

Over the next half a decade, Brazilian banks are also expected to benefit from preparations for the two mega sporting events the nation is going to host — the 2014 Soccer World Cup and the 2016 Rio Olympics. The federal government has started implementing several large-scale, capital-intensive projects to spruce up the country’s infrastructure ahead of the games, and some banks, especially the large government-owned ones like Banco do Brasil, are providing capital for some of these projects.

Industry Trends

• The massive monetary boost it received from the government in the middle of the recession not only helped the Brazilian economy recover from the crisis speedily but also post an impressive 7.5% GDP growth in 2010. However, with inflationary pressures building, the central bank has taken several steps to slow down the economy without bringing it to a halt. However, although interest rates have been rising through 2011, credit growth has not moderated appreciably, adding to concerns about a possible credit bubble in the Brazilian economy. In fact, a Reuters report indicates that credit in the Brazilian economy is projected to grow 15%-20% in 2011, although interest rates on consumer loans have touched 40%.
  
  
• In the wake of the Brazilian central bank’s efforts to slow down the economy and credit growth, the vulnerability of the smaller banks in the country seems to have been exposed. According to the Financial Times, two small banks were bailed out in the second quarter of 2011 and it is believed that a few more banks may face severe difficulties by the end of this year. Further, the fledgling securitization market in the nation is apparently suffering a crisis of confidence after the central bank reportedly found that a small bank retained loans on its books even after selling them to another bank. Consequently, bigger banks have become skeptical about buying loan portfolios from smaller banks, affecting transactions in the country’s securitization market.
  
  
• Riding on the credit boom, average household debt appears to have risen significantly in Brazil. As of April 2011, the household debt-to-income ratio for the nation was 40%, a figure smaller than those for countries such as the U.S. and Chile, but much larger than the 22% recorded in 2006, according to economic consulting firm LCA Consultores. Moreover, the share of debt payments in the incomes of Brazilian households has also gone up. The debt payment-to-income ratio stands at around 26% now and is projected to advance to 30% by 2012. Notably, the sub-prime crisis in the U.S. broke out when the average debt payments of Americans vis-à-vis their average incomes was approximately 14%. Another cause for concern is that credit card interest rates in Brazil have breached 220%. Presumably, if they continue increasing, the debt burden for some Brazilians may reach unsustainable levels.
  
  
• In line with these trends, loan defaults too have been rising. According to credit rating agency Serasa Experian, in May 2011, loan defaults registered the highest monthly increase since March 2010. And, they indicated a growth of 20.6% during the first five months of 2011. Significantly, consumer credit defaults recorded in Brazil are below the country’s historical average now, but higher than those in most emerging markets, the Financial Times has noted.
  
  
• Brazil is building a positive credit registry to help banks review the credit histories of all borrowers and not just defaulters. Given that the majority of Brazilians who have benefited from the current credit boom are believed to be first-time borrowers, the credit registry should help banks monitor loan disbursal more effectively.
  
  

The new registry notwithstanding, some of the trends in the banking industry raise uncomfortable questions about the possibility of a credit bubble in the short term. Although there are no definitive answers to these questions, some factors do argue against such a bubble. For instance, the Brazilian banking industry is going through a period of structural transformation, where unsecured loans are being replaced by secured ones. Secondly, mortgage-oriented payments still make up only 1% of household income as opposed to 10% in the U.S. What’s more, after touching 47%, interest rates on consumer credit have started declining.

Industry Outlook

Two events signaled the promise the Brazilian banking sector may hold in the long term: The IPO of credit card processing company VisaNet in June 2009 raised $4.6 billion, and Spanish banking group Santander launched the IPO of its Brazilian operations in early October 2009 to raise a record $8 billion. After the listing, Banco Santander Brasil emerged more valuable than some of the bigger global banks.

Undoubtedly, Brazil’s banking industry is at an interesting inflection point. Given that banks’ prospects are intrinsically linked to the health of the broader economy, the Brazilian banking industry’s opportunities for growth appear substantial. After all, the Latin American nation is projected to become the world’s fifth largest economy by 2035, according to Goldman Sachs. The World Bank is more optimistic, stating that Brazil will achieve this status by 2026. Moreover, rising income levels, falling unemployment, and a growing middle class have created the social infrastructure necessary for retail banking to expand.

But that is not to say all appears well with the banking industry in the country. For the first time in the history of the nation, bank credit is truly a part of the average Brazilian’s life. Banks are lending freely and many Brazilians who until recently did not even have a bank account are using credit cards and taking housing loans. If interest rates do not revert to the same elevated levels they have fallen from (for example, levels of 18%-19% in 2005), Brazilian banks are unlikely to sustain their traditionally high net interest margins. Notably, with increased lending to the low-income group, the banking business in Brazil is growing, and so are loan defaults, going by the Serasa Experian data.

Only time will tell if banking too much on the retail borrower will be worth its price.

*Bolsa Família is a popular government social welfare program. It was instituted by the Lula administration to provide financial help to poor families. Households with monthly incomes below a certain level get a flat sum every month, while families with children are entitled to additional sums based on conditions such as school attendance and vaccination requirements.

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