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DE RUEHSO #0011/01 0081515
ZNR UUUUU ZZH
R 081515Z JAN 09 ZDK
FM AMCONSUL SAO PAULO
TO RUEHC/SECSTATE WASHDC 8841
INFO RUEHBR/AMEMBASSY BRASILIA 9997
RUEHRG/AMCONSUL RECIFE 4274
RUEHRI/AMCONSUL RIO DE JANEIRO 8972
RUEHBU/AMEMBASSY BUENOS AIRES 3376
RUEHAC/AMEMBASSY ASUNCION 3623
RUEHMN/AMEMBASSY MONTEVIDEO 2831
RUEHSG/AMEMBASSY SANTIAGO 2623
RUEHLP/AMEMBASSY LA PAZ 4032
RUCPDOC/USDOC WASHDC 3241
RUEATRS/DEPT OF TREASURY WASHDC
RHEHNSC/NATIONAL SECURITY COUNCIL WASHDC

UNCLAS SECTION 01 OF 03 SAO PAULO 000011 
 
SIPDIS 
SENSITIVE 
 
STATE PASS USTR FOR KDUCKWORTH 
STATE PASS EXIMBANK 
STATE PASS OPIC FOR DMORONSE, NRIVERA, CMERVENNE 
DEPT OF TREASURY FOR JHOEK, BONEILL 
 
E.O. 12958: N/A 
TAGS: ECON EFIN EINV ETRD BR
SUBJECT: BRAZILIAN MEDIUM-SIZE BANKS: KEY TO SMES 
 
REF: A. Sao Paulo 0593; B. Sao Paulo 0548; C. Brasilia 1417 
 
SENSITIVE BUT UNCLASSIFIED--PLEASE PROTECT ACCORDINGLY 
 
¶1.  (SBU) Summary:  Representatives from five medium-size banks and 
the World Bank's International Finance Corporation met at Consulate 
General Sao Paulo on December 18 to discuss the operating 
environment for medium-size banks, major problems in the sector, and 
possible steps forward for 2009.  They believe Brazil's banking 
sector is becoming more concentrated as a result of recent GOB 
measures; however, existing regulations and the prominent role of 
state-owned banks are factors that contributed to an already 
extremely concentrated banking system with the top 10 banks holding 
80 percent of time deposits.  Maturity mismatches between short-term 
deposits and longer-term loan portfolios have created some liquidity 
concerns, especially among mid-size banks.  Medium-size banks play 
an important role in helping to diversify loan portfolios of small 
and medium enterprises (SMEs) in Brazil.  Brazil does not have bank 
customers for mid-size banks to mirror the U.S. model of regional 
banking.  According to the panel, the GOB needs to actively promote 
and create incentives for medium-size banks to survive over the 
long-term.  SMEs play an important role in the Brazilian economy and 
massive failures of small and medium banks would impact the 
Brazilian economy.  End Summary. 
 
Representation 
-------------- 
 
¶2.  (SBU) Representatives from five medium-size banks and the World 
Bank's International Finance Corporation met at Consulate General 
Sao Paulo on December 18 to discuss the operating environment, major 
problems in the sector, and possible steps forward for 2009.  The 
roundtable hosted by the US Treasury Financial Attache included Beny 
Parnes and Joao Carlos Pinho, Directors at Banco BBM; Andrew 
Gunther, Brazil Country Manager and Bruno da Cruz Carneiro from the 
International Finance Corporation; Cassio von Gal from Banco Fibra; 
Sergio Lulia Jacob from the Arab Banking Corporation (ABC) Brasil; 
and Andre Jafferian Neto from Sofisa. 
 
Even More Concentrated 
---------------------- 
 
¶3.  (SBU) Brazil's banking system is very highly concentrated. 
According to Fitch Ratings, at the end of June 2008, the 10 largest 
Brazilian banks by equity accounted for 78 percent of the banking 
system's assets, 80 percent of deposits, and 69 percent of equity. 
Beny Parnes, Director at Banco BBM told Econoff that the 
concentration of the banking sector has significantly increased in 
recent years and that the credit crunch has increased market share 
for the six largest banks.  (Comment:  An example of this was the 
recent merger announcement of Unibanco and Itau to form the largest 
bank in Brazil.  See Ref A for more info.  End Comment.)  Likewise, 
several panelists noted that the largest banks have benefited from 
the financial crisis as concerned customers moved their deposits to 
big banks (flight to quality), further concentrating capital in the 
hands of a small number of financial institutions.  An example of 
this can be found in the relative amount of certificates of deposit 
(CDs) held by small and medium banks.  From April to December 2008, 
CDs at small and medium banks went from 23 percent of total CDs to 
11.5 percent. 
 
¶4.  (SBU) Parnes told Econoff that Brazil's regulatory framework 
does not stimulate more competition because it inherently favors 
larger banks.  He cited as an example the recent Central Bank (BCB) 
and Brazilian Securities Exchange Commission (CVM) measures that 
encouraged large banks to purchase medium-size bank portfolios as 
further reducing market share for medium-size banks (Refs B and C). 
The panel discussed that Brazil's system of deposit guarantees also 
indirectly favors larger banks given their client base.  The Credit 
Guarantee Fund (FGC) only guarantees deposits up to R$ 60,000 per 
person for banks that pay into the fund (administered by Febreban). 
As a result, the FGC primarily protects individual account holders, 
who are more likely to keep their deposits at the larger banks. 
Medium-size bank customers, mostly small and medium-size businesses 
(SMEs) with business accounts, have minimal protection under current 
regulations.  Parnes underscored that Brazilian banks would find it 
 
SAO PAULO 00000011  002 OF 003 
 
 
more difficult to attract deposits because of the lower deposit 
guarantees.  Andre Jafferian Neto from Sofisa noted that Sofisa's 
branch in Miami was not facing flight to quality problems right now 
because of the U.S. federally insured deposits. 
 
¶5.  (SBU) Parnes further posited that the popularity of state banks, 
noting the perception that Brazilians feel more secure with 
state-owned banks, also undermined competition.  Of the 10 largest 
banks, three federal banks, the National Development Bank (BNDES), 
Caixa Economica Federal, and Banco do Brasil account for 40 percent 
of assets, 45 percent of deposits, and 37 percent of equity. 
 
 
Maturity Mismatches, Funding Concerns 
------------------------------------- 
 
¶6.  (SBU) Parnes told Econoff that maturity mismatches are a huge 
problem in Brazil right now.  Time deposits, the largest source of 
funding for Brazilian banks, are flexible and consumers can pull out 
money quickly, often resulting in maturities of one day or more. 
Parnes stated that 70 percent of time deposits held by large banks 
can be withdrawn before maturity.  Bank loans, on the other hand, 
have a longer fixed term.  He noted this problem was more severe in 
medium-size banks, but that large banks also had issues. 
 
¶7.  (SBU) The panel also highlighted that Brazilian banks have 
traditionally focused funding efforts on CDs and not on other 
instruments.  According to Fitch, traditional deposits have provided 
about 50 percent of the Brazilian financial system's funding, and 
the remainder comes mainly from the domestic capital market.  Even 
before September 2008, international markets provided less than 10 
percent of funding, most of which primarily went to large 
corporations.  In addition, the panel told Econoff that although 
Brazilian banks can issue bonds, Brazilian Treasuries crowd out 
private bank bonds. 
 
¶8.  (SBU) Low penetration rates for banking further limit funding 
opportunities for Brazilian banks.  The BCB indicated that nearly 40 
percent of Brazil's 5,500 municipalities do not have a retail bank 
or banking service window.  Parnes noted that the majority of 
Brazilians do not have bank accounts because they are poor.  Medium 
banks cannot compete with larger banks for the retail consumers and 
generally provide more commercial banking for SMEs, further limiting 
their deposit base. 
 
Medium-Size Banks and the SMEs 
------------------------------ 
 
¶9.  (SBU) The panel discussed SMEs performance amid the global 
credit crunch.  Despite cutting down on new financing, the higher 
cost of capital on existing credit lines is choking otherwise good 
companies.  They lamented that SMEs could not have expected to alter 
growth expectations from five percent down to 0 within two months 
time.  Jafferian stated that the average interest rates on SME 
working capital loans were 17 percent per year in 2007, and had 
risen to about 23 percent by April 2008, and were 35 percent per 
year in December.  He does not believe rates back down to 25 percent 
are possible in the near-term.  They postured that the lack of new 
credit to roll over existing debt, higher borrowing costs, and lower 
revenues would mean higher defaults for SMEs in 2009.  They all 
agreed that SMEs could start passing off any insolvency issues to 
the medium banks.  Von Gal pointed out that no one wants a solvency 
crisis among the SMEs, especially the big banks. 
 
Not Like U.S. Mid-Size Banks 
---------------------------- 
 
¶10.  (SBU) Jafferian noted that Brazil does not have the broker 
deposit system that exists in the U.S.  Pinho agreed that U.S. 
regulations had artificially kept banks smaller and fostered the 
development of regional banks.  Given the lack of penetration, 
Brazil cannot support regional banks.  Unlike the specialization of 
services and sheer scale within the U.S. banking system, Jafferian 
stated that Itau and Bradesco hold a virtual monopoly on retail 
services because they had invested millions into software and other 
services.  Smaller banks are unable to match these perks. 
 
SAO PAULO 00000011  003 OF 003 
 
 
 
Where to Go from Here? 
---------------------- 
 
¶11.  (SBU) The group spent considerable time discussing the future 
for medium-size banks.  Von Gal questioned whether the GOB wanted to 
keep medium banks in the system and compared them to a Brazilian 
soldier going into battle in Iraq without adequate training.  They 
agreed that the GOB needs to define a function for medium banks 
within the system and create the regulatory framework that supports 
it.  Von Gal stated that medium banks for decades have suffered 
liquidity crises every four years, a pattern that does not allow for 
long-term planning.  Jafferian stated that the BCB is well aware of 
the need for more banks and that medium banks keep total credit 
costs down and offer loans in which large banks have no interest. 
He also noted that medium banks also help diversify the risk across 
the system--a SME typically has financing from seven or eight banks. 
 Jafferian, a representative of the Brazilian Mid-Size Bank 
Association (ABBC), said that ABBC was working closely with the BCB 
to find ways to help medium banks.  As an example, Jafferian 
highlighted that the GOB had authorized BNDES loans for SMEs, in 
which BNDES would provide the funding, and medium banks would assume 
the risk. 
 
¶12.  (SBU) Attendees applauded the BCB's efforts to keep the 
financial system functioning and for its regulation of the banking 
system.  Von Gal noted that the BCB would have to begin absorbing 
medium bank portfolios, which the group agreed would only happen 
after a series of other efforts failed.  They all noted that GOB 
officials would likely fear personal liability repercussions under 
that scenario.  Jacob pointed out that Brazilian banks cannot 
continue to operate based on the expectation for emergency measures. 
 They all advocated diversification of funding and creation of new 
instruments as a positive way to preserve medium banks.  They cited 
the Receivables-Backed Investment Fund (FIDC) as a new instrument 
that was created as a vehicle for small companies to get access to 
capital that could not go the IPO route.  There are some 250 of 
these funds in Brazil that banks and asset managers contribute to, 
but are considered risky and have not yet started operating. 
 
¶13.  (SBU) Jafferian closed the discussion by stating that Brazil 
has the most secure financial system in the world.  Real estate 
loans are only three percent of total credit (and only two percent 
of GDP); auto loans, though problematic, have a liquid tangible 
value; Brazil's average default rate is three to six percent; the 
payroll-linked loans are solid because the public sector guarantee; 
many medium banks are well capitalized following IPOs last year; and 
BCB supervision is very good and requires all activities be recorded 
on the balance sheet. 
 
Comment 
------- 
 
¶14.  (SBU) Due to the nature of the Brazilian banking sector, the 
near-term impact of the global slowdown on Brazilian SMEs is a 
concern despite the relatively limited use of international credit 
lines and the high capitalization ratios.  While consolidation is a 
likely outcome under current conditions, even if the 10 largest 
medium-size banks merged, their combined efforts would not compare 
to any of the largest big banks in Brazil.  Small and medium banks 
would need better market conditions and a higher degree of bank 
utilization among Brazilians to begin to gain ground in Brazil. 
Despite their limited size, however, SMEs are a very important piece 
of the Brazilian private sector that cannot afford to lose its 
primary fundingbase.  End Comment. 
 
¶15.  (U) This cable was cleared by Embassy Brasilia and with the US 
Treasury Financial Attache in Sao Paulo. 
 
WHITE