The Real economic stabilization plan of July 1994 has generated chaos in the financial system. This in turn is pressuring the government to create a new set of rules to stimulate restructuring and therefore strengthening the banking institutions. Brazil has 246 banks more than Canada and France and according to the economy minister Pedro Malan this is not a good sign. There are too many banks for too little money, he argues. Malan believes that the new economic environment in Brazil will cut this number in half by the end of the century.
In 1988, Brazil had 100 domestic banks and the new constitution loosening the requirements to open up such institutions paved the road to a boom in the financial system. Inflation fueled an easy way to make profits and banking became a good business. For example, banks would act as government agents collecting water and energy bills from the population but those funds would only be passed to the government three days later.
At the time, Brazil was running an average 80% monthly inflation rate and three days represented an 8% easy gain. In 1993, the 40 biggest banks earned $9.1 billion from this floating money 26% of the banks' total receipts added to the $2.1 billion in profits. But in the first six months of 1995, this number had declined to $203 million accounting for less than 1% of their total receipts and followed a $1.4 billion drop in profits. The inflation was profitable for the banks but left them weak administratively and laggard in adapting to a new stable economy.
The Central Bank's president, Gustavo Loyola, defends the idea that banking mergers are essential to strengthen Brazil's financial system. Usually, these banks for sale are in bad shape and the government needs to create a mechanism to stimulate other financial institutions to take over these white elephants.
The PROER, Program of Stimulus to Restructure and Strengthen the National Financial System, was put together by the Cardoso government to help banks merge and acquire one another. Loyola believes that "the program is not to benefit a single system but the whole economy." He sees banks as a heart in the economy pumping investments into all sectors. The PROER has the full support of two former economic ministers, Mário Henrique Simonsen and Ernane Galvêas, who see an urgent need to adjust the country's financial system to a new era.
The restructuring of financial systems is not a Brazilian phenomenon, but a global occurrence. It's continually happening in the US. In Japan, the Bank of Tokyo merged with the Mitsubishi Bank, and in Hong Kong, the Bank of East Asia merged with the United Chinese Bank. The Dutch ING Bank acquiring the bankrupted British Barings reinforces the phenomenon. The globalization increases competition which forces banks to increase receipts and decrease costs.
This justifies the changes in many international banks. The Crédit Commercial de France merged with the Bank of Montreal, the Itamarati Bank acquired the Crefisul, the Itaú Bank bought the Banco Francês-Brasileiro, and the Hong Kong Shangai Bank associated with the Bamerindus Bank which in turn sold 6% to the Midland Bank.
Since July 1994, the Brazilian Central Bank liquidated 15 banks and intervened in another six. The Banerj (Bank of the State of Rio de Janeiro) and the Banespa (Bank of the State of São Paulo) are two large state-owned banks under intervention due to bad administration and politics. In this interventionist process, the Bank Bozano, Simonsen won a bid to administer and then privatize the Banerj, under the Central Bank since the end of 1994. The Bozano, Simonsen has been an aggressive player in the process of privatization of state owned enterprises and thus has a vast experience in cleaning bankrupt businesses turning them into profitable ones.
This innovative process of intervention and privatization used by the Central Bank opens up avenues to a new way of dealing with problematic institutions, delegating the cleaning-up job to the private sector. Even though the Banerj is to be privatized, the São Paulo state government has been reluctant to do the same with Banespa. Moreover, a larger bomb dropped in the country's financial market was the Banco Econômico. Econômico, an old private Brazilian bank, was put under the Central Bank intervention after a $3.5 billion shortfall.
The Econômico had to be split into two: the profitable side of it was sold to the much smaller Excell Bank and the other is under the government intervention for eventual liquidation. The Excell has been required to inject $309 million to increase the capital of the new bank. Despite the financial crisis, the Banco Excell bid to buy the Econômico had the Swiss Bank support, a sign of confidence in the Brazilian banking system.
Banco Nacional, created in 1944 in the state of Minas Gerais, was the latest financial institution to go belly up. It was Brazil's seventh largest bank. The Nacional was acquired by another bank from Minas, the Unibanco, the sixth largest Brazilian bank, which was founded in 1924. These two institutions represent traditional Brazilian families running business as small shops.
The deal generated the third largest Brazilian bank. Citibank and the Bank of Boston bought the left-over agencies from the Nacional. The merger represents a $500 million reduction in expenses for the two banks involved. This figure represents more than the two institutions were expecting to profit in one year.
According to a Lloyds Private Bank's consultant, the Brazilian economy can handle no more than 150 banks, a little over half of the existing number. Mergers and acquisitions will continue. The merging of institutions result in huge gains from economies of scale and reduction in costs.
1. Banks acquiring other banks will have an official line of credit to re-organize the new bank. This line of credit will have a lower interest rate than those charged in the market. The funds come from the state to the entrepreneur.
2. The buying bank may deduct the loss of the other institution in the income tax of the new bank.
3. The stocks of the sold institution held by private investors will have to be traded in the market to a value 40% lower or sold to the new institution at a price stated in the bank's last annual fictitious balance-sheet. These will no longer be accepted by the new bank at its current value.
4. The $10 billion funds come from the Central Bank, Banco do Brasil and the Caixa Econômica Federal.