Banking and Financial Deepening in Brazil

Brazil is the largest nation in Latin America, with over half of the total land mass and approximately half of the population. The economy produces about half of the region’s aggregate gross domestic product, and is one of the most diversified economies of the developing world. Close to 60 per cent of merchandise exports consists of industrial products, and these are diversified across many commodity lines.

The financial system in Brazil is unique in several respects. In this chapter we focus on one aspect of the Brazilian financial system which gives it a distinct and unique character: monetary correction. Monetary correction was adopted in piecemeal fashion, but now covers most aspects of financial activity.

This chapter is divided into four main sections. In section 3.2 are presented three different ways to correct the continuous loss of purchasing power of wages in an inflationary environment. We concentrate our attention on the two mechanisms that have been used in Brazil: The ‘peak adjustment’ and the ‘average adjustment’. In the former case, wages are corrected, taking into consideration only past inflation. In the latter, future inflation must be forecast to permit the calculation of the nominal wage adjustment necessary to keep its purchasing power at the previous prevailing value. These different methodologies lead to completely different situations with respect to combating inflation, and are a key step in understanding the inflationary process in Brazil. The ‘peak adjustment’ is generally referred to in the literature as lagged (backward-looking) indexation. The ‘average adjustment’ is better defined as an incomes policy than as a method of indexing wages. It also is referred to as ‘forward-looking indexation’.

In terms of economic development, the eighties have proved fruitless to Brazil. Table 4.1 compares the average rate of growth of real GDP with previous periods. Sectoral data related to industrial and agricultural product are also included. One can easily observe, from lines (1), (2) and (3), the sharp deterioration of product rates of growth in the eighties. Growth of industrial product, which averaged 7.0 per cent in the sixties and 9.4 per cent in the seventies, was reduced to an average increase of 1.4 per cent between 1980 and 1988. At the same time, the average annual increase in agricultural production declined from 4.2 per cent in the last two decades (2.9 per cent in the sixties and 5.5 per cent in the seventies) to 2.6 per cent in the eighties. Following this trend, real GDP growth displayed a very poor average rate of increase of 2.3 per cent per year. This is quite low when compared to the 5.9 per cent in the sixties or the 8.7 per cent in the seventies. If we take a longer period for purpose of comparisons, the conclusion remains the same. Brazilian GDP growth averaged 6.2 per cent between 1920 and 1980, and 7.1 per cent between 1950 and 1980.

Two recent events of a legal nature are expected to exert a significant impact on the structure and functioning of Brazil’s financial system. One is the new Brazilian constitution which was promulgated on 5 October 1988. Chapter IV (specifically, Article 198) sets forth certain legal guidelines for a banking reform law which is to be enacted by Congress. The other is Central Bank Resolution 1.524, dated 21 September 1988, establishing the bases for a multiple bank system of financial institution organisation, modelled essentially along Mexican lines and having been developed with support from the World Bank.

The objective of this chapter is to introduce the reader to Brazil’s banking institutions by means of a description of the different categories presently recognised by the authorities as being banks or conducting business which is essentially that of a bank. It is important to keep in mind the material contained in Chapter 5 with respect to Multibanks, as many of the institutional types described herein can optionally become converted into departments of a single banking institution.

The non-banking institution segment of the financial industry offers considerable potential for long-term growth as well as short-term profits. This segment generally is involved in developing and intermediating longer term sources of finance for rapidly growing corporations, as well as in managing wealth. In accordance with the evolving multi-bank concept, this segment would be separate from the banking system and would include institutions involved in capital markets, insurance, investments and possibly leasing. (Reference should be made to Table 7.5 and related material in Chapter 5.)

The Brazilian money market has developed rapidly since the early 1970s. In part this development can be attributed to the strenuous efforts of public sector and private sector agencies to promote the ‘open market’. During the latter half of the 1970s especially, the Ministry of Finance operated in a most intelligent way in sponsoring legislation aimed at financial market development. Nevertheless problems appeared, and progress was hampered. At times prices surged ahead of projected inflation rates, yielding investors negative real returns in some money market assets. Persistent inflation placed a premium on shortening the maturities of money market instruments, as a defence tactic. Parallel shortenings of wages contracts and other patterns of price adjustment soon followed, magnifying tendencies towards market disequilibrium.

One can view the development of Brazilian capital markets as encompassing four specific but related developments. In a broad sense all four are tied together, and in various ways contributed to the deepening of the financial markets. These four specific developments include: We discuss items 1 and 3 primarily in this chapter. Item 2 is discussed in the following chapter. In part we have outlined the activities of short-term mutual funds in Chapter 8.

The stock exchanges in Brazil date back approximately a hundred years. For example, the Rio and São Paulo Stock Exchanges were organised in 1845 and 1890, respectively. In total, Brazil has nine stock exchanges which operate as non-profit associations. Close to 95 per cent of trading takes place on the two largest exchanges in Rio and São Paulo. For that reason the focus of this chapter is on these two dominant market places.

The period 1974–86 is the subject of the next several sections. We focus on this period for a number of reasons. First, it is a period which follows the economic miracle of 1968–73, when economic growth was maintained at double digit levels for a number of years. Second, it is a period in which numerous external shocks beset the Brazilian economy. Third, it is a period in which the macroeconomic environment of Brazil underwent many changes. From the point of view of corporate financial activity, it was a dynamic and changing period, when inflation rates accelerated and the international terms of trade of Brazil deteriorated as basic commodity prices (exports) declined below prices of manufactured goods and equipment (imports). Aggravating these tendencies was a rapid increase in external debt, rising interest rates, a slowdown in domestic investment, and an increase in the relative role and importance of the public sector compared with the private sector. Towards the end of this period Brazil moved quickly in the direction of participative democracy, with the election in 1984 of Tancredo Neves to the Presidency. Neves was not in good health and died before he could be placed in office. His successor, President Sarney, took office. According to the Constitutional Convention that was operative in Brazil in 1987–8, there will be a presidential election in 1989.

The decade of the 1980s brought with it new economic problems for Brazil. In this chapter we consider these problems within the context of the debt conversion programme introduced by the government. In the following chapter we consider these problems in the context of the privatisation programme introduced in 1988.

Brazil has experienced a unique development of its economy. In the process the state has expanded its sphere of activities, by regulation, by defining certain sectors of industry as of central national interest, and by financing industrial development. A first approach to understanding the privatisation programme in Brazil is to say that the economy appears ready to reverse much of what has been done in the way of expanding the role of the state in economic activity. But this is an oversimplification.

Brazilian capital market development has been built on four basic pillars: (1) a normalisation of the capital markets through the introduction of legislation and regulations that provide a stable legal structure; (2) development of a broader and more active stock market; (3) creation of financial institutions that mobilise capital and intermediate investment funds; and (4) development and encouragement of venture capital activities. We have discussed the first and third of these in Chapter 9, which focuses on the capital market. Development of the stock market has been considered in Chapters 9–10. In this chapter we focus on the development of venture capital activities.