By Taimur Ahmad
In nature, organisms often acquire immunity through contact with diseases, learning to recognize them, and adapting to withstand future encounters.
While few today would argue that Latin America’s banks are immune to external shocks, their extraordinary resilience in the wake of the 2008 global crisis left many wondering what went right.
For Roberto Setúbal, chief executive of Itaú-Unibanco, Brazil’s largest private bank, the answer is clear: banks in Latin America knew the shape of a crisis and, after many years of exposure to them, had built up their defenses accordingly.
“In Brazil, we had a banking crisis in the 1990s. After that crisis, banks became more conservative,” he tells LatinFinance in an interview. “This is true across Latin America: banks here took fewer risks, they had a high capital base and this was the basis of their resilience.”
Latin American banks, unlike their US and European counterparts, had also shunned excessive leverage, he says, aware of its pitfalls. “Banks were very conservative in general, not getting into high leverage. This was definitely an important factor in Latin America’s credit resilience – its low dependence on external funding and high reliance on domestic deposits,” says Setúbal.
For Latin America’s banks, this was conservatism born of experience: higher capital ratios, more liquidity and enhanced efficiency all helped the industry cope better with the effects of the global crisis on credit. “In Brazil, we had more capital requirements for many types of risk, which were not a requirement for banks in the developed world,” he says.
Setúbal, who took over as head of Itaú in 1994, flatly rejects the view that it was Latin banks’ relative lack of sophistication that inadvertently spared them from the impact of the global financial crisis – or that, if the region’s banks had had the opportunity, they would have been every bit as brash as their Western counterparts in dabbling in complex, and potentially unsound, financial instruments.
“It’s not really a matter of having these instruments, structured and leveraged finance, or what have you,” he says. “At the end of the day, regardless of what kind of instruments you have, it’s all about leverage.”
The fact is simply that Western banks were overly leveraged, he says. “At some point, too high leverage leads to volatility in the market and then banks get in trouble,” he says. “Banks in the developed world took more risk than they should have. Many of them regret what was done in the past and they would not do it again today.”
In contrast, banks in Latin America simply “did not take risks as banks in the developed world took.”
Of course, it helped that the spillover effects of the global crisis to the region’s economies was also limited, thanks in part to the buffers in place at the macro level. “This was quite important in allowing the banks to go through this period,” Setúbal says.
Yet as the environment for Brazil’s banks deteriorates following a sharp slowdown Latin America’s largest economy, questions have emerged anew over how well the country’s banking sector will stand up to the undesirable turn.
With Brazil’s economy stalling, demand for credit is falling. After expanding just 0.9% last year, the economy is expected to grow by no more than 2.3% in 2013.
The downturn has already taken its toll on the domestic credit market, with a surge in loan delinquencies over the past two years. And moves by the central bank to curb inflation by hiking borrowing costs could yet exacerbate the problem in the year ahead.
“The Brazilian economy has had a significant slowdown compared to the last decade. This has created some problems in terms of the credit markets,” Setúbal says, adding that he regards Brazil’s downturn as part of a broader phenomenon affecting emerging markets, rather than a country-specific event. “There is a slowdown in emerging economies more deeply, and Brazil is part of that. This is a new thing, a new phenomenon and we have to readapt our economies [to slower growth].”
Nevertheless, he insists that the Brazilian banking sector has seen the worst of the downturn and that the level of bad loans is under control. “The worst of the problem is behind us. We are moving to a better and more controlled level of delinquency in general, so this is not a problem anymore.”
Financial results bear this out, he says. Itaú’s delinquency rate declined to 4.2% in the second quarter of 2013 from 4.5% in the first quarter and 5.2% a year earlier. Moreover, the bank’s profits of 3.62 billon reais beat analysts’ expectations for the quarter, following a two-year strategy to reduce risk.
Setúbal, an engineer by training and widely known for his prudence, says Itaú’s improved performance does not mean the lender is about to take on more risk. “Two years ago we announced that we were changing our risk appetite, that we would move out of higher risk segments and that the benefits of this strategy would be down the road,” he says. “We are not really considering at all changing our risk policy at this point.”
Brazil’s lenders also face concerns that embattled EBX Group, which is struggling to contain its own financial crisis, will default on bank loans. But Setúbal says that even a “worst case” outcome – a default by the troubled group – would not have a major impact on the country’s banking sector. “Given the level of exposure of banks in Brazil to EBX Group, it is not really a problem at all in terms of systemic risk,” he says. “In the worst case scenario [of a default] we would not change our guidance in terms of provisions or losses,” he says. The bank expects to provision between 19 billion reais ($9.2 billion) and 22 billion reais for loan losses in 2013.
Setúbal nevertheless acknowledges that the dramatic collapse of the EBX Group has taken its toll on investor perceptions of Brazil. “Eike Batista was pretty much associated with an image of a new Brazil as a very high growth country with a lot of potential where things could happen quite fast. And the failure of Eike [Batista’s company] definitely goes against this perception,” he said. “This is definitely not good for Brazil.”
New rules, old problems
What is good for Brazil, however, Setúbal says, are Basel III international regulatory standards set to take effect in the country on October 1. The new measures, when implemented across Latin America, will make the industry “more resilient”, he says, although given its underlying strength will require only a minimal adjustment. “Latin America was already much more prepared,” Setúbal says. “The gap from where we were just before the crisis to the implementation of Basel III is much smaller for us than for developed countries.”
As a vice-chairman of the Washington-based Institute of International Finance (IIF), a global banking lobby group, Setúbal is no stranger to the debate over regulatory reform.
But the view that Latin America’s banking system is already adequately capitalized and so will have no problem implementing new capital requirements draws a sharp contrast with the position of banks in developed countries, who argue that the Basel III rules are too stringent.
Does he sympathize with his colleagues in New York, London and elsewhere bemoaning the likely impact of new rules on their business? Or should they simply learn the lessons of their Latin counterparts? “There’s always something to learn, especially in adapting and modernizing, in evolving and improving regulation,” he says. “Regulation is key in order not to drive players to take more risk.”
But he is cautious not to push the point too far, acknowledging that there remain many unknowns for the global banking industry. “We still have not seen the results and impact of all this new regulation and especially on the capital requirements will have in terms of making the system more resilient.
“The level of risk will reduce with the additional level of capital. So overall, we will have a much more resilient financial system, there’s no doubt about that. There is also a side effect. Financial intermediation will be more costly and this will have some impact also in terms of credit expansion.”
Regulation – whether Basel III or efforts to break up “too big to fail” banks – is always a trade off, he says. “At the end of the day, you have to ask: how much insurance do you want and how much are you willing to pay for it? There’s no free lunch. The price of this will come through the cost of credit, because it will go higher. This is what we have to balance.”
Yet ultimately, it’s a trade off that Setúbal has already made. The downside – if it is one – to such conservatism is that the world of banking could simply become a duller place. But that prospect doesn’t bother Setubal in the slightest: “Banking is a business which is much closer to a marathon than a sprint. It’s something that you have to look for the long run,” he says. “This is my own experience.” LF