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Cablegate: Brazil's Central Bank Sets New Reserve Requirements On

VZCZCXRO4814
RR RUEHRG
DE RUEHSO #0086/01 0531252
ZNR UUUUU ZZH
R 221252Z FEB 08
FM AMCONSUL SAO PAULO
TO RUEHC/SECSTATE WASHDC 7929
INFO RUEHBR/AMEMBASSY BRASILIA 9080
RUEHRG/AMCONSUL RECIFE 4009
RUEHRI/AMCONSUL RIO DE JANEIRO 8595
RUEHBU/AMEMBASSY BUENOS AIRES 3068
RUEHAC/AMEMBASSY ASUNCION 3316
RUEHMN/AMEMBASSY MONTEVIDEO 2621
RUEHSG/AMEMBASSY SANTIAGO 2317
RUEHLP/AMEMBASSY LA PAZ 3726
RUCPDOC/USDOC WASHDC 3033
RUEATRS/DEPT OF TREASURY WASHDC
RHEHNSC/NATIONAL SECURITY COUNCIL WASHDC

UNCLAS SECTION 01 OF 02 SAO PAULO 000086

SIPDIS

STATE PASS USTR FOR KDUCKWORTH
STATE PASS EXIMBANK
STATE PASS OPIC FOR DMORONSE, NRIVERA, CMERVENNE
DEPT OF TREASURY FOR JHOEK

SENSITIVE
SIPDIS

E.O. 12958: N/A
TAGS: ECON EFIN EINV BR
SUBJECT: BRAZIL'S CENTRAL BANK SETS NEW RESERVE REQUIREMENTS ON
LEASING DEPOSITS


SENSITIVE BUT UNCLASSIFED--PLEASE PROTECT ACCORDINGLY

1. (SBU) SUMMARY: The Brazilian Central Bank (CB) has established
new reserve requirements on commercial leasing operations in order
to close a loophole that allowed companies to avoid Brazil's high
reserve requirements. This action will also serve to tighten
credit, control inflation, improve efficiency of monetary policy,
and extend equal treatment to the different funding instruments
available to the banking system. These measures are designed to
further insulate the Brazilian economy from the U.S. credit crisis,
with the goal of reassuring investors that Brazil remains a viable
investment option. The CB will enforce the new rules gradually
beginning in May through January 2009 at which time the CB will
require banks to deposit 25 percent (similar to that applied to time
deposits) of their capital stock derived from leasing companies.
The reserve requirements may curb credit growth on the margins but
are unlikely to derail the continued expansion of Brazil's credit
market. Overall, the measure is likely to put off short-term
interest rate hikes, and will signal that the CB is taking measures
to strengthen Brazil's credit market. END SUMMARY.

Progressive Reserve Requirements for Leasing
--------------------------------------------

2. (SBU) On January 31, the Brazilian Central Bank (CB) instituted
new capital requirements for commercial leasing operations,
including banks and other leasing agents, that had been exempt from
reserve requirements. Brazil is home to the world's highest reserve
requirements, and one of the few countries that still imposes
reserve requirements on time deposits. Unlike traditional demand
deposit reserve requirements, the new CB requirement grants
provisions for the reserves for leasing operations to be invested in
federal bonds rather than sitting as cash in the CB vaults.
According to CB data, in December 2007, demand deposits were
approximately USD 70 billion, time deposits USD 166 billion, and
savings deposits USD 140 billion. As of November 2007, the
inter-bank deposits of leasing companies at the banks were
equivalent to nearly USD 90 billion. The reserve requirements will
increase by five percent every two months beginning at five percent
in May through January 2009 to 25 percent. The CB publicly said it
expects credit liquidity to shrink by approximately USD 22.5 billion
this year; a move designed to keep inflation near the CB's target of
4.5 percent for 2008.

Leasing Loophole
----------------

3. (U) Leasing makes up approximately seven percent of total bank
lending; however, many banks had been using their own leasing
companies to raise capital via debentures which could be deposited
at banks without any reserve requirements. Last year, leasing
companies issued 70 percent of total debentures to banks in order
for them to avoid reserve requirements via other financial
instruments. [Note: Debentures are long-term debt instruments used
by governments and large companies to obtain funds. End Note.]
Personal credit expanded 32 percent last year and financial analysts
continue to predict growth above 20 percent for 2008. The rapid
growth in leasing has been fueled, in part, by the Brazilian legal
regime which often finds for the debtor in cases of default. As a
result, banks began utilizing leasing arrangements (in this case not
to increase their own financing) as a way to limit their liability
as leasing allows a bank to retain ownership of the asset and
eliminates the lengthy process for repossession in the event of
non-payment.

Impact Likely Minor
-------------------

4. (SBU) The CB's new requirements are unlikely to derail credit
growth this year. The measure appears to roll back Brazil's credit
expansion; however, other credit instruments will probably be used
to replace some of what would have been financed via leasing
companies. Indeed, Jose Pedro Fachada, the Executive Manager of
Investor Relations at the CB (strictly protect) told Econoffs that
the CB views the new requirement not as a monetary policy tool, but

SAO PAULO 00000086 002 OF 002


rather as a signal to discourage banks from using leasing as a
loophole to get around reserve requirements. He said the CB would
have required cash reserves had it been a monetary policy decision.
[Note: The CB has historically used reserve requirements as a
monetary policy tool to control inflation when interest rate hikes
were ineffective. End Note.] According to Credit Suisse, the
volume of leasing operations rose by 86 percent last year in an
effort to evade reserve requirements. Fachada said the CB had
studied various measures designed to address this market imbalance
with a goal of giving equal treatment to alternative funding
sources. The CB judged that leasing was distorting the credit
market, and that 2007 showed that banks were using leasing to get
around reserve requirements, he added. Furthermore, the Senior
Advisor to the CB Board Alexandre Pundek (strictly protect) noted
that it was not a punitive measure that required banks to pass
capital to the CB, but that banks could use other instruments as
"collateral" and prevent any measurable loss to the credit market.
Fachada noted that the measure would likely affect smaller banks
that had been using leasing and not big banks that have access to
other financial instruments to apply toward this requirement.
Pundek acknowledged that banks will no longer have access to leasing
as a cheap source of capital and that spreads would likely increase.
He noted, however, that it was difficult to say by how much because
the regulation would affect banks differently. He speculated that
banks that had aggressively used leasing for self-financing might
have to raise their rates by 0.5 percent, but underscored that it
was impossible to predict given the unique financial situations for
each bank.

Less Cheap Lending
------------------

5. (U) The measure ultimately reins in banks' ability to secure
cheaper capital. Financing firms are predicting a loss of
approximately USD 17 billion in available credit from the financial
system in 2008. Pundek explained to Econoff that each bank must
deposit all proceeds from new leasing toward their reserve
requirement until the bank reaches its 25 percent maximum reserve
requirement for all existing leasing stock. The effective loss of
credit could be smaller if banks can apply other financial
instruments including federal bonds toward their reserves for
leasing activities. The Director of the Brazilian Federation of
Bank Associations (FEBRABAN) privately told Econ Specialist that he
expects the new measure to have some negative impacts on the banking
sector, including reduced credit growth and subdued profitability.
Economic analysts, including Merrill Lynch economic analyst Alex
Cancherini, told Econoff that determining the exact loss of funding
at each of the banks would be difficult to assess. He noted that
based on CB figures, Brazil's largest banks including Itau,
Bradesco, and Unibanco have been the most prominent users of leasing
to increase their financing. However, Brazilian banks are extremely
well insulated, very highly capitalized, and due to record profits
last year are uniquely positioned to deal with this tightening of
credit.

6. (SBU) COMMENT: With the addition of reserve requirements for
leasing, the CB reaffirmed that Brazil is removed from the U.S.
credit crisis by closing out the remaining loophole in Brazil's
credit system. The measure was an effort, in part, to highlight the
strength of Brazil's financial system and to maintain business
confidence. The measure also potentially deflates some of the
credit expansion and decreases the likelihood of interest rate hikes
while curbing inflationary pressure as well. If the survey
completed earlier this year by the Brazilian bank Bradesco in which
interest rate hikes are cited as the most important factor for
investment decisions in Brazil is accurate, this move should signal
to investors that Brazil remains a good investment location. END
COMMENT.

WHITE

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