VZCZCXRO4814
RR RUEHRG
DE RUEHSO #0086/01 0531252
ZNR UUUUU ZZH
R 221252Z FEB 08
FM AMCONSUL SAO PAULO
TO RUEHC/SECSTATE WASHDC 7929
INFO RUEHBR/AMEMBASSY BRASILIA 9080
RUEHRG/AMCONSUL RECIFE 4009
RUEHRI/AMCONSUL RIO DE JANEIRO 8595
RUEHBU/AMEMBASSY BUENOS AIRES 3068
RUEHAC/AMEMBASSY ASUNCION 3316
RUEHMN/AMEMBASSY MONTEVIDEO 2621
RUEHSG/AMEMBASSY SANTIAGO 2317
RUEHLP/AMEMBASSY LA PAZ 3726
RUCPDOC/USDOC WASHDC 3033
RUEATRS/DEPT OF TREASURY WASHDC
RHEHNSC/NATIONAL SECURITY COUNCIL WASHDC

UNCLAS SECTION 01 OF 02 SAO PAULO 000086 
 
SIPDIS 
 
STATE PASS USTR FOR KDUCKWORTH 
STATE PASS EXIMBANK 
STATE PASS OPIC FOR DMORONSE, NRIVERA, CMERVENNE 
DEPT OF TREASURY FOR JHOEK 
 
SENSITIVE 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: ECON EFIN EINV BR
SUBJECT: BRAZIL'S CENTRAL BANK SETS NEW RESERVE REQUIREMENTS ON 
LEASING DEPOSITS 
 
 
SENSITIVE BUT UNCLASSIFED--PLEASE PROTECT ACCORDINGLY 
 
¶1.  (SBU) SUMMARY: The Brazilian Central Bank (CB) has established 
new reserve requirements on commercial leasing operations in order 
to close a loophole that allowed companies to avoid Brazil's high 
reserve requirements.  This action will also serve to tighten 
credit, control inflation, improve efficiency of monetary policy, 
and extend equal treatment to the different funding instruments 
available to the banking system.  These measures are designed to 
further insulate the Brazilian economy from the U.S. credit crisis, 
with the goal of reassuring investors that Brazil remains a viable 
investment option.  The CB will enforce the new rules gradually 
beginning in May through January 2009 at which time the CB will 
require banks to deposit 25 percent (similar to that applied to time 
deposits) of their capital stock derived from leasing companies. 
The reserve requirements may curb credit growth on the margins but 
are unlikely to derail the continued expansion of Brazil's credit 
market.  Overall, the measure is likely to put off short-term 
interest rate hikes, and will signal that the CB is taking measures 
to strengthen Brazil's credit market.  END SUMMARY. 
 
Progressive Reserve Requirements for Leasing 
-------------------------------------------- 
 
¶2.  (SBU) On January 31, the Brazilian Central Bank (CB) instituted 
new capital requirements for commercial leasing operations, 
including banks and other leasing agents, that had been exempt from 
reserve requirements.  Brazil is home to the world's highest reserve 
requirements, and one of the few countries that still imposes 
reserve requirements on time deposits.  Unlike traditional demand 
deposit reserve requirements, the new CB requirement grants 
provisions for the reserves for leasing operations to be invested in 
federal bonds rather than sitting as cash in the CB vaults. 
According to CB data, in December 2007, demand deposits were 
approximately USD 70 billion, time deposits USD 166 billion, and 
savings deposits USD 140 billion.  As of November 2007, the 
inter-bank deposits of leasing companies at the banks were 
equivalent to nearly USD 90 billion.  The reserve requirements will 
increase by five percent every two months beginning at five percent 
in May through January 2009 to 25 percent.  The CB publicly said it 
expects credit liquidity to shrink by approximately USD 22.5 billion 
this year; a move designed to keep inflation near the CB's target of 
4.5 percent for 2008. 
 
Leasing Loophole 
---------------- 
 
¶3.  (U) Leasing makes up approximately seven percent of total bank 
lending; however, many banks had been using their own leasing 
companies to raise capital via debentures which could be deposited 
at banks without any reserve requirements.  Last year, leasing 
companies issued 70 percent of total debentures to banks in order 
for them to avoid reserve requirements via other financial 
instruments.  [Note: Debentures are long-term debt instruments used 
by governments and large companies to obtain funds.  End Note.] 
Personal credit expanded 32 percent last year and financial analysts 
continue to predict growth above 20 percent for 2008.  The rapid 
growth in leasing has been fueled, in part, by the Brazilian legal 
regime which often finds for the debtor in cases of default.  As a 
result, banks began utilizing leasing arrangements (in this case not 
to increase their own financing) as a way to limit their liability 
as leasing allows a bank to retain ownership of the asset and 
eliminates the lengthy process for repossession in the event of 
non-payment. 
 
Impact Likely Minor 
------------------- 
 
¶4.  (SBU) The CB's new requirements are unlikely to derail credit 
growth this year.  The measure appears to roll back Brazil's credit 
expansion; however, other credit instruments will probably be used 
to replace some of what would have been financed via leasing 
companies.  Indeed, Jose Pedro Fachada, the Executive Manager of 
Investor Relations at the CB (strictly protect) told Econoffs that 
the CB views the new requirement not as a monetary policy tool, but 
 
SAO PAULO 00000086  002 OF 002 
 
 
rather as a signal to discourage banks from using leasing as a 
loophole to get around reserve requirements.  He said the CB would 
have required cash reserves had it been a monetary policy decision. 
[Note: The CB has historically used reserve requirements as a 
monetary policy tool to control inflation when interest rate hikes 
were ineffective.  End Note.]  According to Credit Suisse, the 
volume of leasing operations rose by 86 percent last year in an 
effort to evade reserve requirements.  Fachada said the CB had 
studied various measures designed to address this market imbalance 
with a goal of giving equal treatment to alternative funding 
sources.  The CB judged that leasing was distorting the credit 
market, and that 2007 showed that banks were using leasing to get 
around reserve requirements, he added.  Furthermore, the Senior 
Advisor to the CB Board Alexandre Pundek (strictly protect) noted 
that it was not a punitive measure that required banks to pass 
capital to the CB, but that banks could use other instruments as 
"collateral" and prevent any measurable loss to the credit market. 
Fachada noted that the measure would likely affect smaller banks 
that had been using leasing and not big banks that have access to 
other financial instruments to apply toward this requirement. 
Pundek acknowledged that banks will no longer have access to leasing 
as a cheap source of capital and that spreads would likely increase. 
 He noted, however, that it was difficult to say by how much because 
the regulation would affect banks differently.  He speculated that 
banks that had aggressively used leasing for self-financing might 
have to raise their rates by 0.5 percent, but underscored that it 
was impossible to predict given the unique financial situations for 
each bank. 
 
Less Cheap Lending 
------------------ 
 
¶5.  (U) The measure ultimately reins in banks' ability to secure 
cheaper capital.  Financing firms are predicting a loss of 
approximately USD 17 billion in available credit from the financial 
system in 2008.  Pundek explained to Econoff that each bank must 
deposit all proceeds from new leasing toward their reserve 
requirement until the bank reaches its 25 percent maximum reserve 
requirement for all existing leasing stock.  The effective loss of 
credit could be smaller if banks can apply other financial 
instruments including federal bonds toward their reserves for 
leasing activities.  The Director of the Brazilian Federation of 
Bank Associations (FEBRABAN) privately told Econ Specialist that he 
expects the new measure to have some negative impacts on the banking 
sector, including reduced credit growth and subdued profitability. 
Economic analysts, including Merrill Lynch economic analyst Alex 
Cancherini, told Econoff that determining the exact loss of funding 
at each of the banks would be difficult to assess.  He noted that 
based on CB figures, Brazil's largest banks including Itau, 
Bradesco, and Unibanco have been the most prominent users of leasing 
to increase their financing.  However, Brazilian banks are extremely 
well insulated, very highly capitalized, and due to record profits 
last year are uniquely positioned to deal with this tightening of 
credit. 
 
¶6.  (SBU) COMMENT: With the addition of reserve requirements for 
leasing, the CB reaffirmed that Brazil is removed from the U.S. 
credit crisis by closing out the remaining loophole in Brazil's 
credit system.  The measure was an effort, in part, to highlight the 
strength of Brazil's financial system and to maintain business 
confidence.  The measure also potentially deflates some of the 
credit expansion and decreases the likelihood of interest rate hikes 
while curbing inflationary pressure as well.  If the survey 
completed earlier this year by the Brazilian bank Bradesco in which 
interest rate hikes are cited as the most important factor for 
investment decisions in Brazil is accurate, this move should signal 
to investors that Brazil remains a good investment location.  END 
COMMENT. 
 
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