Brazilian banking sector – a view from 30,000 feet

The Brazilian economy experienced an acceleration of economic growth over 

the course of the past decade. Economic growth was underpinned by improving 

terms of trade, rising exports, broadly supportive macro-policies, solid credit 

growth and a supportive fiscal policy.

Rising domestic consumption was supported by – amongst other things –

increasing government transfers, rising incomes, rising employment and 

expanding domestic credit. Consumption growth was particularly pronounced 

among the poorer classes. Increasing domestic credit, especially bank lending 

to the private sector, was itself a function of reform (e.g. bankruptcy code,

crédito consignado or payroll-deducted loans) and the improvement in overall 

economic conditions (e.g. booming labour market, increasing formalization of 

the labour market, lower domestic interest rates).

As a result, Brazil experienced a sustained increase in lending to the private 

sector. Bank lending to the private sector almost doubled between 2003 and 

today, rising from 24% of GDP to 47%. Although many emerging economies 

experienced rapid credit growth, Brazil is among only a handful of major 

emerging economies that saw bank lending double (as a share of GDP). 

Total bank credit does not appear to be unsustainably high. Other emerging 

markets have far higher levels of bank lending. This suggests that credit has 

room to continue to grow. It is worth mentioning, however, that sooner or later 

sustained growth will require a larger contribution from mortgage-related 

lending. Consumer lending is already relatively high in Brazil.

Bank credit*, % of GDPBrazilian banking sector - a view from 30,000 feet

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In terms of the composition of bank lending to the private sector, consumer 

credit has experienced the largest increase. This is to a large extent a direct 

consequence of the reforms mentioned above. Bankruptcy reform has improved 

creditor rights, making banks more willing to lend. Payroll-deducted lending, 

allowing for civil servant social security payments to be used as a collateral, has 

induced banks to boost lending. Lower nominal and real interest rates, although 

they continue to be very high by international standards, have made borrowing 

more affordable for consumers (and businesses). Last but not least, solid 

economic growth and a booming labour market, in turn, have helped improve 

overall credit conditions.

As regards the origin of bank credit, both the public and the national private 

sector banks have roughly doubled their lending as a share of GDP. By 

contrast, foreign-owned banks not only had a smaller market share initially, their 

market share has also grown more modestly. It is noteworthy that banks wholly 

or partially owned by the state (BNDES, Caixa, Banco do Brasil) originate more 

bank credit than the national private sector banks. This, however, is not unusual 

in emerging economies.

Brazil has quite a segmented loan market. Loans can be divided into so-called 

‘earmarked’ and ‘non-earmarked’ credit. Earmarked credit refers to credit 

operations with compulsory allocation and/or government resources. 

Specifically, there exist directed-lending requirements specifying that a fixed 

share of deposit liabilities needs to be lent to the agricultural and housing sector 

at below-market interest rates. In addition, BNDES, the state-owned 

development bank, directly (and indirectly, so-called on-lending) offers credit at 

below-market interest rates. Non-earmarked credit, by contrast and by definition, 

is not subject to directed-lending requirements.

Lending rates remain extremely high. Historically, the cost of default (or loss 

given default) has been the most important contributor to loan spreads (that is, 

spreads over the risk-free rate), explaining as much as 50% of the total spread.

1

By contrast, reserve requirements, which are similarly extremely high by 

international standards, explain, according to the central bank, only around 5% 

of the loan spread. Thanks to improving macroeconomic conditions and a fall in 

nominal and real interest rates, Brazil has experienced a moderate lengthening 

of loan maturities in recent years. This trend will continue as domestic interest 

rate continue to decline over the medium term. 

In spite of the rapid growth in domestic bank lending, the substantial increase in 

riskier consumer lending and the lengthening of loan maturities, the Brazilian 

banking sector (in the aggregate) remains in solid shape.

— The capital adequacy ratio remains high. As a matter of fact, Brazil has the 

highest CAR of the major EM-9 countries.

— In terms of liabilities, Brazilian banks’ dependence on wholesale funding is 

high, but manageable overall, not least because banks typically hold large 

amounts of liquid assets in the form of government debt securities.

— Brazil’s reliance on foreign funding (as a share of total liabilities) – of special 

concern given the persisting risk of further rounds of global volatility – is 

quite low.

— Due to very high reserve requirements (far higher than in other emerging 

economies), the authorities have an important crisis-management tool at 

their disposal (as the 2008 shock demonstrated).

  ... but Brazil is not unusual in this

respect 3Brazilian banking sector - a view from 30,000 feet

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— Banks’ liabilities and assets are largely denominated in local currency and 

local foreign-currency lending is prohibited (unlike in Eastern Europe, for 

instance) and banks face strict limitations in terms of the FX risk they are 

allowed to run.

The outlook for the Brazilian banking system is also helped by Brazil’s solid 

economic fundamentals, its sensitivity to commodity price developments and the 

recent decline in economic growth notwithstanding. 

First, external vulnerability (as opposed to sensitivity) is low. Brazil has been 

experiencing significant capital inflows over the past few years. However, a 

large equity component has helped limit potential risks related to the now 

sizeable stock of portfolio liabilities owed to non-residents, as has the very 

significant increase in FX reserves. FX reserves have increased from 

USD 200 bn in early 2009 to USD 365 bn today. Brazil’s external solvency and 

liquidity position remains strong. In net terms, both the sovereign and the 

economy as a whole are net foreign (currency) creditors. While the currency 

itself is vulnerable to a sharp depreciation in the event of a balance-of-payments 

shock, such a shock, unlike in the past, would not have systemically

destabilising consequences, including for the banking sector.

Second, the creditworthiness of the government is solid. For what it is worth, it 

carries an investment grade rating. The fiscal stance is sufficiently conservative 

to ensure the continued decline in the net debt-to-GDP ratio. On current trends, 

it might fall to as low as 30% of GDP by 2015-16 from 36-38% of GDP at the 

moment. Gross debt remains relatively high, but to a significant degree this 

reflects public sector asset accumulation (e.g. lending to official financial 

institutions and FX reserve accumulation). The government’s capacity to support 

the financial sector in the unlikely event of a crisis is considerable and will 

continue to grow as government debt continues to decline.

The government has ample scope to recapitalise the banking sector. A back-ofthe-envelope calculation demonstrates this. Gross general government debt at 

present amounts to 55% of GDP or so. Assuming – very conservatively – a real 

‘equilibrium interest rate’ of 7%, real GDP growth of 3% and a primary surplus of 

2.4% (below the present 3.1% of GDP target), the government could afford an 

increase in debt of 10-20% of GDP (equivalent to 20-40% of total bank lending) 

without undermining debt sustainability. Given that the general government has 

claims on official financial institutions (mostly BNDES) amounting to 7-8% of 

GDP, with the latter accounting for 10% of GDP of bank lending, it is clear that 

the government’s ability to support the banking sector is actually far greater, 

potentially amounting to 2/3 of all domestic bank lending – and this assumes 

that the government would not impose any losses on banks’ equity and debt 

holders. In short, the government is in a position to provide a very substantial 

backstop in the unlikely event of a banking sector crisis.

Given large capital buffers at the systemic level actual losses will obviously be 

far smaller. Brazil and Brazilian banks are currently benefiting from strong labour 

markets, rising real incomes, ample capital inflows and historically low real 

interest rates – and the economy is expected to pick up steam in the second 

half of this year. Historically, however, periods of rapid credit growth usually lead 

to an increase in credit risk. Brazil is unlikely to be an exception. The good news 

is that – at the systemic level – capital buffers look adequate to cope with rising 

default rates. 

In short, the outlook for the banking sector is fair. True, Brazil has experienced 

bank failures over the past ten years, but they never represented a serious risk 

to systemic banking sector stability.The same is likely to hold true in the 

foreseeable future. That said, a sustained economic downturn, including a 

weakening of the labour market, would negatively impact on banks’ consumer 

loan portfolios, not least because this segment has experienced the highest 

Source: FitchBrazilian banking sector - a view from 30,000 feet

growth in recent years. A moderation in consumer lending is desirable. 

Consumer lending (excluding mortgage lending) is already quite high. For 

consumer lending to continue to expand at a solid but sustainable rate, 

mortgage lending would have to take off. Declining nominal and real interest 

rates, if sustained, might yet make this a possibility.