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Cablegate: Brazilian Central Bank Takes Precautions for Banks

VZCZCXRO3662
RR RUEHRG
DE RUEHSO #0548/01 2841611
ZNR UUUUU ZZH
R 101611Z OCT 08
FM AMCONSUL SAO PAULO
TO RUEHC/SECSTATE WASHDC 8611
INFO RUEHBR/AMEMBASSY BRASILIA 9748
RUEHRG/AMCONSUL RECIFE 4223
RUEHRI/AMCONSUL RIO DE JANEIRO 8886
RUEHBU/AMEMBASSY BUENOS AIRES 3273
RUEHAC/AMEMBASSY ASUNCION 3520
RUEHMN/AMEMBASSY MONTEVIDEO 2791
RUEHSG/AMEMBASSY SANTIAGO 2520
RUEHLP/AMEMBASSY LA PAZ 3928
RUCPDOC/USDOC WASHDC 3185
RUEATRS/DEPT OF TREASURY WASHDC
RHEHNSC/NATIONAL SECURITY COUNCIL WASHDC

UNCLAS SECTION 01 OF 02 SAO PAULO 000548

SIPDIS
SENSITIVE

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

E.O. 12958: N/A
TAGS: ECON EFIN EINV ETRD BR
SUBJECT: BRAZILIAN CENTRAL BANK TAKES PRECAUTIONS FOR BANKS

REFS: A. Sao Paulo 0486; B. Sao Paulo 0522; C. Brasilia 1299; D. Sao
Paulo 0086

SENSITIVE BUT UNCLASSIFIED--PLEASE PROTECT ACCORDINGLY

1. (SBU) Summary: Brazil's banking system is well positioned to
weather the external financial crisis. Brazilian bank assets are of
good quality and the banks themselves, especially the larger
institutions, have high levels of liquidity. Because of capital
adequacy requirements, Brazilian banks are not as highly leveraged
(only six to seven times), have reserves that outpace their
respective Basel ratios, and lack derivatives and other financial
instruments commonly found in the U.S. Economic interlocutors
agreed that although the Brazilian system has enough liquidity
without external credit lines, it is not balanced across the system.
Small and medium banks are less liquid because they were more
reliant on external credit lines and have a smaller deposit base
upon which to draw. In response, the Central Bank (BCB) has taken
several measures in recent weeks to redistribute liquidity across
the system. The BCB's conservative behavior, including the
stockpile of more than USD 205 billion in foreign reserves and high
reserve requirements for banks appears to be a sound strategy to
protect Brazil's banking system. Likewise, the Brazilian banking
sector appears ready to defend itself. Although the impact and
potential for bank failures is small, both the banks and Brazilian
authorities are unwilling to take that chance and are moving
proactively to keep the banking system healthy. End Summary.


2. (U) While Brazilians spent the last year of the worldwide
financial crisis preaching the strength of the Brazilian economy,
economists and government officials alike have slowly altered their
rhetoric and actions given events over the last several weeks.
Following the collapse of Lehman Brothers in September, Brazilian
authorities from the Central Bank (BCB) and central government have
undertaken several important precautionary measures to rebalance the
liquidity within the Brazilian financial system to protect its
integrity. (Note: See Refs A, B, and C for more on Brazil and the
U.S. financial crisis. End Note.) In line with its conservative
approach to regulating Brazil's financial system, the BCB intervened
in foreign exchange markets in October, postponed planned increases
to reserve requirements on leasing operations (Refs C and D),
partially lifted the reserve requirement for large banks on time
deposits, used foreign reserves to provide foreign currency for
exporters, and is also planning relief for agriculture finance.

3. (SBU) The BCB's actions represent an attempt to rebalance
liquidity between small and large banks. The Brazilian banking
system is solvent and has plenty of liquidity within the system.
However, banking interlocutors told Econoff that large banks
generally hold most of the available liquidity while small banks
rely heavily on external financing. On October 2, the BCB eased
reserve requirements on time deposits, essentially allowing large
Brazilian banks to use up to 40 percent of their reserve requirement
for time deposits (invested in GOB bonds) to purchase assets from
smaller banks (defined as banks with capital up to R$ 2.5 billion).
(Note: this is approximately 11 percent of the banking system based
on net worth. End Note.) Joaquim Eloi Cirne de Toledo, a director
at Nossa Caixa, told Econoff that this measure of allowing large
banks to purchase assets from small banks was a welcome solution to
redistributing up to R$ 22 billion (approximately USD $10 billion as
of publication of this cable) within the Brazilian banking system.
Similarly, the BCB has used dollar auctions to help alleviate the
shortage of export credit lines. Chief Economist at the Federation
of Banks Rubens Sardenberg defined all of these measures as a means
for the BCB and GOB by extension, to gain time until the external
scenario improved (or at least stabilized). He did not believe that
the BCB would intervene and purchase small bank assets at this
point, but instead would wait to evaluate whether the large banks'
actions were sufficient.

4. (SBU) The GOB has strongly supported the BCB's moves to limit
Brazil's exposure to the external financial crisis. The GOB has
urged quick approval of the provisional measures that will authorize
these regulations, as well as one that permits the BCB to directly

SAO PAULO 00000548 002 OF 002


intervene to purchase bank assets as the lender of last resort, if
necessary. President Lula has openly supported the BCB's actions
and has pushed the Brazilian legislature to approve the measures.
Thalis Murrieta, advisor to Senator Jose Tenario (PSDB - opposition
party member and alternate on the Senate Economic Affairs Committee)
told Brasilia Econoff that the measures proposed by the GOB enjoy
broad support in Congress, though the opposition parties were sure
to use the crisis to their political advantage. Murrieta also noted
that the BCB needed the power to intervene not because of problems
with the small banks themselves, but due to potential for crises of
confidence. He asserted that in fact, the books of the small banks
were quite healthy, but that giving the Central Bank this power
would have a stabilizing influence.

5. (SBU) On October 9, the GOB granted the BCB the permission to
intervene in banks in need of assistance. The BCB will have the
authority to demand the sale of assets, block new business
initiatives, and freeze the salaries of executives. Several
contacts have told Econoff that large banks were already
uncomfortable with small banks going under and the BCB's measures
have created financial incentives for large banks to intervene.
According to Alexandre Schwartsman, Chief Economist at Santander,
large banks typically hold reserves above their requirement, so they
are more likely to take the opportunity to use these reserves to
purchase smaller bank assets. Similarly, Gilberto Meiches, Vice
President of small Brazilian bank Banco Sofisa, told Econoff that
his bank was open to the opportunity to sell some of its credit
portfolio and that many other small banks would agree.

COMMENT
-------

6. (SBU) Comment: Brazil's position in withstanding external
financial instability is a result of prudence and good luck. The
BCB has consistently faced criticism that its conservative policies
have restricted economic growth; however, those policies have
resulted in a strong and very cash heavy banking system. Brazil is
fortunate because the global credit crunch has hit at a time when
Brazil's credit cycle is just beginning to grow. Given the external
scenario, the BCB is less likely to continue raising the benchmark
interest rate, with some interlocutors suggesting the BCB would
begin halting further increases as early as the end of October. The
GOB's support has been a key to the BCB's ability to get the job
done, but it has been the BCB's conservative stance on regulatory
and monetary policies that has paid dividends. True to its nature,
the BCB probably will wait for its measures to take effect before
jumping in as the lender of last resort. End Comment.

7. (U) This cable was coordinated/cleared by Embassy Brasilia.

WHITE

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