Privatization and Restructuring of Banks in Brazil by

1
Privatization and Restructuring of Banks in
Brazilby

• WERNER BAER
• NADER NAZMI

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1.Introduction

• Decades of inflation hyperinflation in 1980s and
  the early 1990s almost 50 of monthly inflation
  in mid-1994
  
• With Real Plan stability had been achieved the
  rate declined to 0.6 in December 1994 and by
  June 1998 the rate was 4
  
• Institutional problems created by the new
  stabilization
  
• State banks Exacerbation of an already ongoing
  process of degeneration
  
• Private banks It revealed significant
  structural weaknesses
  

3
Figure 1 Annual Inflation Rates 1989-98
Source IBGE. Note The 1998 data is for the firs
t 6 months of the year.
4

• The government had to restructure the banking
  system by using the central bank
  
• Privatization of the state banks
• Intervention in some of the troubled private
  banks
  

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In this article,

• The examination of the origins of Brazils state
  and private banks,
  
• and how the decades of inflation produced
  distortions in the way they functioned
  
• The crises emerged with the stabilization,
• and the measures taken by the central bank to
  deal with them
  
• The implications of the newly emerging banking
  structure
  

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2. Brief historical perspective

• Prior to the 20th century, banking system weak
  and regionally concentrated
  
• In 1888, 26 banks in only 7 of 20 states
• Over half of the deposits in Rio de Janeiro
• In 1890, three new regional bank loosening bank
  legislation
  
• The result speculative financial and stock
  market boom inflation and devaluation

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• Many banks overextended themselves loans to
  shaky enterprises, and accepting stock of
  questionable value as collateral
  
• Sizable loans from government to those banks to
  avoid a total financial collapse
  
• The state enforced two largest bank to merge into
  Banco da Republica
  
• It became official government agent
• By the beginning of 20th century nationalized
  Banco do Brasil

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• By 1912, the banking system dominated by Banco do
  Brazil and a small number of foreign banks
  
• By 1920s, very precarious banking structure
• Rondo Camerons measure to judge the size of the
  banking system
  
• The number of financial institutions per ten
  thousand inhabitants as an index
  
• The idea Anything under 0.50 density was low

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• Low Banking coverage in Brazil considering per
  capita deposits
  
• Continuation of regional concentration in the
  first three decades of 20th century
  
• After WW-I a substantial growth of commercial
  banks
  
• In 1920s, appearance of a number of state banks
  with the aim of aiding agricultural sector
  
• Other state banks founded in the 1930s
• The major objective Small and medium-sized
  firms and agriculture

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• By 1970s, 24 state commercial banks many state
  development and savings banks
  
• In the early 1950s, the foundation of National
  Bank for Economic Development (BNDE)
  
• BNDE an important policy tool in financing
  infrastructure and industrial investments
  
• Some regional development banks, and in 1960s a
  Housing Bank
  
• The extent of the growth of government banks?

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• A series of financial reforms in the mid- and
  late 1960s
  
• Profound changes in the structure of the
  financial system
  
• the share of loans by banks from 86.3 in 1963
  to 40.6 in 1985
  
• Banco do Brazil from 33.31 to 10.93
• other state-owned commercial banks 39.27 to
  5.33
  
• private commercial banks rose from 13.72 to
  24.35
  
• bank concentration

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Table 1
 
Table 1 Brazil Number of Commercial Banks
 
 
  Source Lees, Botts and Cysne (1990), p. 125
Boletim do Banco Central do Brasil, Relatorio
1996.
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• One aim of these reforms to encourage Brazils
  large private banks to open branches in less
  developed regions
  
• This occurred, but the concentration of the loans
  in the more developed regions continued

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3.Bank behavior during high inflation periods

• Inflation helped Brazilian banks in three way
• Easy revenue-negative or low real interest rate
• Reduction of the real value of their liabilities,
  shrinking the likelihood of insolvency
  
• Addition of liquidity
• The meaning of the end of the inflation

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• The inflationary climate led to an explosive
  growth in the number of
  
• Commercial banks
• Branches of already established public and
  private banks
  
• Yearly inflation rates averaged
• 17.3 in the 1950s
• 44.8 in the 1960s
• 33.8 in the 1970s
• Reaching three digits in the 1980s, and four
  digits in the first half of 1990s
  

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Table 2 Number of Private Banks and Branches  
Source Banco Central do Brasil.
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• In the inflationary environment banks were making
  large sum of money based on the float
  
• A revenue based on various types of low cost
  liabilities (tax receipts, demand deposits,
  collateral against loans, etc.)
  
• Banks used these almost free resources to invest
  in short-term securities that paid high nominal
  interest rates
  
• The high rates of return caused new banks to be
  created

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• As inflation worsened in 1980s and early1990s,
  banks continued to expand rapidly
  
• Modernization of the banking system, but more and
  more risky loans
  
• Decline in the quality of the operations of state
  banks, beginning in the early 1980s-linked to
  return to democracy
  
• State banks as instruments to finance state
  budget deficits in the inflationary environment

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• Banks greatly benefited from inflation revenues
  during 1990-94
  
• Treasury operations-arbitrage on interest rates
  and currencies
  
• Float on basic banking services
• With the stabilization after mid-1994
  profitability depends increasingly on lending and
  fee income
  
• The role of the financial system in the economy
  diminished as inflation diminished
  

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Table 3 Inflation Revenues of Brazilian Banks
( of Total Revenues)
 
Nm-not meaningful
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Table 4 Share of Financial Institutions in GDP
()
 
Source Banco Central do Brasil and IBGE.
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4. Stability and institutional change

• With the end of high inflation banks helped
• By a healthy rise in consumer expenditures
• By a jump in demand for credit
• GDP and consumption grew smartly during 1994-95
• The effect of installment credit, success of Real
  Plan, and increased real wages

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Figure 2 GDP and Consumption Growth Rates in
Brazil 1993-96

Source Conjuntura Econômica.
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• Credit to individuals rocketed by more than 180,
  figure 3
  
• The reasons of extension of credit and exposure
  to risk
  
• Sound risk analysis and management unnecessary in
  the past
  
• Implicit and explicit government insurance, lax
  supervision
  
• The result of strong domestic currency and
  gradual reduction in tariffs was trade deficit
  

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Figure 3 Percentage Change in Brazilian Private
Banks Credit to Trade and Housing Sectors and to
Individuals

Source Conjuntura Econômica.
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Figure 4 Imports, Exports, and Trade Balance,
1987-97

Source Conjuntura Econômica.
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• Current account deficit financed by inflow of
  foreign capital
  
• However, 1994 Mexican crisis and following
  Tequila effect in 1995
  
• The meaning of adverse external shock under
  flexible exchange rate
  
• Currency depreciation
• Rise in prices
• Decline in the real value of banks assets and
  liabilities
  

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• Under Brazils almost fixed exchange rate
• Balance of Payment crisis
• Higher credit cost
• Worsening of banks crisis
• Central Bank had to increase the interest rate
  substantially,fig. 5
  
• Federal funds rate approached 70 by the end of
  the first quarter of 1995

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Figure 5 Brazil Monthly Federal Funds Rate
19951-199712

Source Banco Central do Brasil.
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• The result economic slowdown, defaults and
  bankruptcies, hard time for banks
  
• Extension of credit to riskier borrowers
• The adverse selection problem
• The credit crunch resulting in economic slowdown,
  business losses and non-performing loans, fig. 6

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Figure 6 Non-Performing Loans as a Percentage
of Total Loans in Brazil 1994-96

Source Banco Central do Brasil.
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• The destabilizing effect of the rise in
  non-performing loans on public banks
  
• An examination of 12 state banks reveals
• Losses in excess of R1 billion in 1994-95
• Non-performing loans to public sector was 5 of
  total loans
  
• The four federal banks lost close to R5 billion
  in 1995
  

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5. Banking sector restructuring

• The foundation of Credit Guarantee Fund (FGC)
• The contribution to FGC 0.025 of all balances
• The tools employed by Central Bank to cope with
  banking problems
  
• Liquidation, recapitalization, merger and
  acquisition, restructuring and sales

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• Between July 1994 and December 1996, 25 private
  and one state bank liquidated, four state banks
  placed under RAET (Temporary Special
  Administration Regime)
• In 1995, RAET applied to Banco Economico, at a
  cost of 2.9 billion, and to Bamerindus at a cost
  of 3 billion
  
• In 1996Banco do Brasil recapitalized, which had
  more than 12 billion losses in 1995-1996
  
• Recapitalization also applied to state banks with
  the aim of restructuring and privatizing

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• Program of Incentives for the Restructuring and
  Strengthening of the National Financial System
  (PROER)
  
• PROER offers a system of tax incentive and credit
  facilities
  
• Unibanco acquired Banco Nacional at a cost of
  4.9 billion
  
• The Program of Incentives for the Restructuring
  of the State Public Financial System (PROES)
  
• The aim was to reduce the role of the public
  sector in the financial system
  

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Table 6 Top 8 Banks (in Terms of Asset Size) in
Latin America

Source Latin Trade, July 1998.
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• Through privatization, extinction or
  transformation into non-financial institutions or
  development agencies
  
• RAET has been used more frequently for state
  banks
  
• Private investment banks given federal funds to
  restructure the newly federalized state banks
  and ready them for privatization
  
• The result of the governments interventions in
  the banks between 1995 and 1998 a clear
  downsizing trend, table 7
  

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Table 7 The Evolution of the Banking System in
Brazil 1995-1998

Source Bacen and Banco do Brasil Informações
Relativas ao 1 Semestre 1998.

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Table 8 Population and Bank Branches  
Estimated by authors. Source Banco Central do
Brasil and IBGE.

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Figure 7 Share of Private and State Banks
1996-98

Source Banco Central do Brasil.
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Figure 8 - The Growth Rate of Total Assets
1994-97

Banco do Brasil Informações Relativas ao 1
Semestre 1998.

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• Although by late 1997 bank restructuring
  increased the concentration, net beneficiaries
  ranked between 30-100
  
• Foreign banks allowed to participate in bank
  restructuring process after August 1995
  
• Banks with foreign capital the only segment that
  grew during 1995-97, table 7
  
• By 1998 a number of foreign banks used this
  opening, table 9

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Banking Acquisitions March 1997-September 1998
 

Table 9 Banking Acquisitions March
1997-September 1998

Not made public. Source Ernst Young, in Gaze
ta Mercantil, July 7, 1998 and updated by the
authors.

Not made public. Source Ernst Young, in Gaze
ta Mercantil, July 7, 1998 and updated by the
authors.

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Figure 9 - Foreign Capital Ownership of Banking
Sector Assets

Source Ernst and Young, Folha de São Paulo,
September 3, 1998.

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6. Implications

• The onset of the Real Plan and the subsequent
  stabilization of the economy exposed the
  inefficiencies of the banks
  
• Still remaining relatively inefficient by most
  international standards, figure 10
  
• The role of retreating of public sector,
  increasing penetration of foreign and domestic
  private sector
  

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Figure 10 Efficiency of Major Brazilian and
International Banks (Administrative and Personne
l Expenses Relative to Intermediation and Service
Revenues)

Source Bozano, Simonsen, reported in Gazta
Mercantil, August 12, 1998.

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Figure 11 Measures of Efficiency Clients per
Branch and Electronic Transaction ( of Total)

Source McKinsey, A Chave do DeDesenvolvimiento
Acelerado no Brasil, March 1998 and Banco do
Brasil Informações Relativas ao 1 Semestre
1998.
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Figure 12 Banking Credit to the Private Sector
as a Percentage of GDP

Source McKinsey, A Chave do DeDesenvolvimiento
Acelerado no Brasil, March 1998.

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Table 10 Credit Extended by the Financial
System
( Share)
Source Banco Central do Brasil.
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• The results of privatization and restructuring
  with respect to equity
  
• Social responsibility of public banks, and their
  being abused for political purposes
  
• The question remaining Who will attend to the
  tasks of public banks after their disappearance?
  
• Will the government be able to channel some of
  the sources of private banks to backward regions
  and groups?