The Braziliansit Magazine - Clipping Desk - Da Silva's unlikely allies

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Brazil's banks are no longer public enemy number one.

When Brazilian business people began to rally round Luiz Inacio Lula da Silva during his victorious campaign for the nation’s presidency, many did so in the belief that he would produce the sustained economic growth that has eluded Brazil for most of the past decade.

Some may also have hoped he would rein in the exuberant profits being made in times of crisis by the country’s banking sector and force it to play a bigger role in promoting growth by lending at cheaper interest rates to the productive sector.

But with the president-elect and his advisers taking every chance to reaffirm their commitment to the outgoing government’s tight fiscal policies, it seems unlikely that the lower interest rates and higher employment promised during the campaign will materialise quickly after the new administration takes over on January 1. Indeed the banking sector, until recently seen as public enemy number one by many in Mr da Silva’s Worker’s Party (PT), may turn out to be his government’s most valuable ally.

“The sector is very important for the government,” says Gustavo Hungria, banking industry analyst at Banco Pactual in Rio de Janeiro. “It always has been and it always will be. They will have to play in the same team.”

Banks are so important to the government because they are its biggest source of credit. At the end of September, banks, pension funds and others held RDollars 658.8bn ( $168.9bn) in federal government bonds issued on the domestic market. Total government debt as a percentage of gross domestic prod uct doubled during the eight years of the outgoing administration. It is no exaggeration to say that government would have been impossible without the support of the banks.

Such support does not come cheaply. The Central Bank recently raised its base rate from 18 to 21 per cent. Fixed-rate government debt issued now for repayment early next year pays about 23 per cent a year. The 40 per cent devaluation of Brazil’s currency this year - caused largely by fears that Mr da Silva would win October’s election - has produced annualised returns on some notes linked to the exchange rate of more than 70 per cent. If banks can earn returns like these lending to a low-risk borrower such as the government, it is not surprising that they charge much higher rates to high-risk borrowers such as companies and private individuals - nor that this is reflected in their profits.

Bradesco, Brazil’s biggest private sector bank, made profits in the first three quarters of 2002 of RDollars 1.33bn, an annualised return on equity (ROE) of 17.2 per cent.

Banco Itau, the second-biggest private bank, made RDollars 1.69bn, an annualised ROE of 27.1 per cent. Profits at both banks were less than those of a year earlier (Itau’s annualised ROE in the first nine months of 2001 was 38.7 per cent). One reason is conservative provisioning for bad loans. Another is that they chose to calculate earnings from the depreciation of the currency at a conservative exchange rate, on the expectation that the real will recover during the fourth quarter. These decisions have led some to wonder whether the banks are deliberately containing their profits to avoid unwelcome attention at a time when the rest of the economy is stagnant.

“It’s certainly possible there is a political element,” says Sandra Utsumi, chief economist at Banco Espirito Santo in Sao Paulo. “Banks also like to demonstrate firm action over non-performing loans to improve their credit ratings for future debt issues.”

Both banks deny that levels of provisioning are determined by such factors.

“Provisions are always arrived at through technical considerations of market volatility,” says Roberto Setubal, president of Itau.

If the banks have anything to fear from the next government, it is that it may force them to lend more to social projects such as low-cost housing. They could also suffer from changes in taxation. And they may fear that a PT administration would take measures to reduce the huge spreads - an average of nearly 40 percentage points - that banks charge when lending to the private sector.

“We don’t believe in interest rate controls, just as we don’t believe in price controls or capital controls,” says Mr Setubal.

But while some members of the PT may be tempted to take such measures, it is unlikely that the new government will risk confrontation with the banking sector. “Everything they do will be based on long negotiations,” says Ms. Utsumi.

“The PT has shown it understands there is no point in picking a fight with the banks. The more uncertainty or conflict there is, the less willing banks will be to provide the government with the long-term finance it needs.” How banks fare under the incoming government will probably have more to do with that government’s success in promotinggrowth than with any policies aimed directly at the sector.