Wednesday, March 02, 2011

Some Fear Potential Brazilian Credit Crisis

FT: Brazil May Be Heading for a Subprime Crisis
Investopedia: Recapitalization

More Brazilians have begun borrowing to purchase everything from school supplies to liposuction, and analysts worry Brazil is headed toward a credit crisis.

Many Brazilians are in the rising middle class and are spending more money on credit than ever. Brazilians have little financial education, but banks have expanded lending to include the growing middle class. In the past ten years, the number of credit cards in Brazil has increased from 28 million to 153 million, and credit card sales rose from $26.7 billion to $186 billion.

Although Brazilian inflation has fallen, interest rates remain extremely high, and banks are profiting greatly from these rates. Private individual interest rates on loans and credit cards are around 20 to 30 percent, but some may be as high as 40 percent. Many Brazilian banks reported huge gains for the previous two years as the amount of credit in the economy has risen from 22 percent of GDP in 2002 to 47 percent today. Defenders of the Brazilian economy are quick to point out that some countries have higher levels of private debt. For example, the United States’ private debt is 165 percent of GDP. However, others still worry this rapid increase in lending in Brazil is creating a “bubble” similar to the one that burst in the United States.

The average individual debt service burden has risen to 24 percent in Brazil, compared to 14 percent in the United States when the subprime mortgage crisis occurred (it is now 12 percent in the United States). The debt service burden for individuals is the percentage of income necessary to repay both the interest and principal on a loan. This means compared to a U.S. consumer, the Brazilian consumer has twice the ratio of debt payments to income. Because of this statistic, many analysts are concerned about a similar, or even worse, credit crisis occurring in Brazil.

Another concern is that Brazil does not have a positive credit bureau that shares credit histories of all consumers (as opposed to a negative credit bureau which only reports on creditors in default). Therefore, Brazil’s system enables consumers to borrow on multiple credit lines without the lenders’ knowledge.

Brazil also has a low savings rate. A country with a low savings rate signifies that not only are consumers probably buying on credit, but also that they will be unable to pay back the loans. In a country like Brazil that does not report credit history, the consumers will be free to continue borrowing, even if they cannot pay back previous loans.

The president and CEO of Brazil’s largest private bank, ItauUnibanco, denied that Brazil is heading into a credit crisis and stated that lending was under control. Nonetheless, commentators continue to compare his actions and similar statements by other banks reporting high profits (in 2010, ItauUnibanco reported record net profit for private banks) to those that occurred before the U.S. sub-prime mortgage crisis.

Analysts warn that signs of trouble are already apparent. In November 2010, when a small bank, Panamericano, was found to be misrepresenting its consumer credit losses, the Brazilian Central Bank recapitalized the bank. Recapitalization changes the company’s capital structure (for example, exchanging bonds for stock) in hopes of making the company more profitable. After Panamericano’s stock fell sharply when further accounting issues were discovered, it was sold to a larger bank. Brazil’s Central Bank insists that this was an isolated incident, but analysts worry that other banks are using the same accounting policies and may suffer the same fate.

While providing credit to the middle class has allowed for huge increases in growth, Brazil should learn from the mistakes made in other countries and carefully monitor the lending industry. However, some worry it may already be too late.

Discussion: Can Brazil learn from the crisis in the United States, or are the economies too different for comparison? Should there be international inquiry into Brazilian lending?

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