Brazil banks are prepared to face new economic shocks – Central Bank

RIO DE JANEIRO, BRAZIL – “In the first half of 2021, the SFN kept provisions high, expected credit losses were reduced, banking system capitalization improved, and liquidity remained stable. This performance is in line with the positive developments in the Brazilian economy, in a period of partial recovery of the economic agents’ confidence and the progress of the vaccination campaign,” the Central Bank reported.

Nevertheless, the agency alerts to the uncertainty surrounding the pace of economic growth, given the risk of new variants of the coronavirus spreading, the difficulty for some production chains to access inputs, as well as potential issues regarding power supply due to the water crisis the country is experiencing.

According to the Central Bank, the profitability of the banks is now at pre-pandemic levels. The system posted net income of R$62 (US$11.3) billion in the first half of 2021, 53% higher than in the same period last year and 3% higher than in the first half of 2019.

The main cause for the rebound in profitability is lower spending on provisions [reserves to pay debt]. “Default under control and lower than expected loss suggest that there will be no significant change in provision expenses in the short term. Consistent improvements in service revenues and administrative expenses growing below inflation have also helped profitability,” the report said.

However, uncertainty remains higher than usual, given the rise in the SELIC benchmark interest rate, which should pressure the cost of credit, as new operations are granted. A potential recovery in activity slower than expected may also affect the system’s profitability in the future.

“The tax reform, if passed by Congress, will impact profitability in different ways. Initially, there will be a revaluation of the tax credit, with no effect on the banks’ cash flow. In the medium term, a lower rate will reduce spending on taxes,” the Central Bank added.

CREDIT

The report also points out that the economic rebound allowed publicly traded companies to improve their economic-financial situation and that large companies have returned to the capital markets. In turn, smaller companies boost bank credit, with annual growth of approximately 35%.

“The growth [of bank credit to micro, small, and medium-sized companies] was significant, despite the end of emergency programs. New growth is expected as of the second half of 2021, with the resumption of incentive programs,” the report says.

The loan market as a whole has grown around 18%. In the case of loans to individuals, growth is occurring in virtually all modalities. According to the Central Bank, real estate financing contracts continue to be boosted by low interest rates, but the share of this type of credit in the Gross Domestic Product (GDP) remains low by international standards.

“Consigned credit has risen due to the increase in its consignment limit, which was extended until December 2021. The strong increase in consumption-oriented modalities [such as non-consigned and credit card] shows a greater appetite for risk by financial institutions, in a context of fewer restrictions on the circulation of the population,” the Central Bank says.

RISKS

Despite the increase in credit concessions, indebtedness and income commitment, when calculated only for individuals who regularly have bank debts, present a slight increase and stability, respectively. According to the Central Bank, this points to the maintenance of the quality of the credit portfolio and shows that, even after a crisis such as last year’s, the behavior of default has remained quite satisfactory.

However, there are risks in the performance of some specific portfolios, such as mortgages with FGTS (Public Guarantee Fund) resources, where defaults have increased. Overall, the surveyed institutions have lowered their concerns about default and activity, but there is caution due to the risks of coronavirus strains that are more resistant to vaccines, the withdrawal of economic stimulus and the persistence of unemployment.

Fiscal risks and the international scenario continued to be mentioned in the Financial Stability Survey. “The first is more closely associated with an increase in concerns about potential policies favorable to fiscal expansion, which impact the sustainability of public accounts. The second is associated with possible monetary adjustments in advanced economies, which may alter costs and flows of resources to emerging economies,” the Central Bank says.

According to the Central Bank’s Supervision Director Paulo Souza, there are also political risks, particularly during the election period, which are always mentioned by institutions. “Everything suggests that we will have a very close, polarized election. I think that the main complication when we talk about an election year is that, during this period, there is a greater aversion to risk on the part of families and companies and this hurts economic activity somewhat,” he said, during an online event to comment on the data in the report.

Yet, since the onset of the Covid-19 pandemic, the market is showing confidence in financial stability far higher than during the 2015/2016 recession. By early August 2021, the confidence level neared the highest historical value observed, reached in 2019.

STRESS TEST

In the stress test, the Central Bank simulates how a severe default and bank run situation impacts compliance with minimum regulatory limits by financial institutions and how much the monetary authority would need to contribute to the financial system. Among these limits are the maintenance of a cash buffer to ensure that banks pay all customers withdrawing money in times of crisis. Credit, interest, foreign exchange, and property devaluation risks are also tested.

The Central Bank considered two scenarios. The first with a combined downturn in economic activity, inflation, and the interest rate. The second would trigger a drop in economic activity, with an increase in inflation and in the interest rate.

The results of the capital stress tests continue to show the resilience of the SFN to absorb the shocks of all simulated scenarios and the results suggest that there would be no “relevant misalignment.” According to the Central Bank, the tests also assessed the impact on capital of the potential approval of the tax reform under discussion in the National Congress.

At the start of the crisis last year, the Central Bank estimated that the system would need R$400 billion in additional provisions and a contribution of R$70 billion in the simulation that considered a severe pandemic shock. In the second half of 2020, there was a very significant reduction in the need for provisions, to R$128 billion, and the impact for the entire financial system would be approximately R$1.5 billion.

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