Brazilian banks have to lend – or else

Stocks around the emerging world have had a tough week, but the Brazilian financial sector has been lagging the rest of the Bovespa, not to mention banks elsewhere. There’s a good reason for this, and it hasn’t been reported widely.

The Brazilian market (EWZ, quote) is down 2.1% since Thursday night, but its biggest financial components have plunged by a much wider margin.

Itau Unibanco (ITUB, quote) is down 5.2%, Bradesco (BBD, quote) has fallen 5.4% and Santander Brasil has shed “only” 3.4% of its value over the last three trading days.

This is not a global flight from the financial sector. Chinese banks like IDCBY (quote) and BACHY, quote), for example, have actually gained ground over the same period.

 

Instead, Brazilian banks are reeling because the government of once-business-friendly President Dilma Rousseff has started threatening their ability to set their own lending terms and turn away borrowers they consider high-risk.

Thursday afternoon, Finance Minister Guido Mantega delivered what amounts to an ultimatum: banks will “free up credit” and lower their lending rates in order to encourage more Brazilians to borrow money to buy more things.

On Friday, he followed through by leaning on the state-run Brazilian Development Bank to make cheaper loans available direct to entrepreneurs, effectively horning in on the for-profit banks’ traditional small business profit center.

Unfortunately, these banks are already lending to Brazilians they consider an acceptable credit risk and are charging the interest rates they consider reasonable to cover the inevitable losses when loans go bad.

As it is, about 7.6% of consumer loans and another 4.1% of commercial loans go into default in Brazil, and  analysts have been alarmed to see defaults soar over last year.

The fact that Brazilian interest rates have declined should normally make it easier for borrowers to manage their payments. Instead, rising default rates indicate that credit quality is declining as banks take more chances.

This is the kiss of death as far as global traders are concerned, who were already nervous about the prospect of one or more Brazilian lenders imploding under the weight of bad loans.

However, the Brazilian central bank — nominally with the consent of President Rousseff and company — still expects lending activity to grow at a rate of 15% this year.

And with President Rousseff herself finding it “inexplicable” that for-profit institutions need to charge consumers about 35 percentage points above the short-term benchmark, their freedom to charge more interest seems to be a vanishing commodity.

Government-run banks like Banco do Brasil (thinly traded as BDORY, quote) can and will lower their interest rates to support consumer spending. But in that kind of race to the bottom, private banks have to either modify their policies to compete or risk more formal policy “suggestions.”

Complying with the government’s wishes will compress profit margins for institutions that are already struggling with cost inflation. Looser lending means higher losses. Lower rates means lower profits. 

It’s a no-brain-cell losing proposition for these banks, and as the story gets out, it should be obvious to traders as well.

ITUB and BBD are world-class banks — when they’re not being tied to the altar of social policy. Until we see them free, it’s likely that the situation will get worse before it gets better — and traders may look for opportunities elsewhere in the emerging world.