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The Anatomy of a Financial Boom

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The Anatomy of a Financial Boom The Quarterly Review of Economics and Finance 52 (2012) 135–153 Contents lists available at SciVerse ScienceDirect The Quarterly Review of Economics and Finance jo urnal homepage: www.elsevier.com/locate/qref Bye, bye financial repression, hello financial deepening: The anatomy of a ଝ financial boom ∗ João Manoel P. De Mello, Márcio G.P. Garcia Department of Economics – PUC-Rio, Brazil a r t i c l e i n f o a b s t r a c t Article history: Since the conquest of hyperinflation, with the Real Plan, in 1994, the Brazilian financial system has grown Received 11 November 2011 from early infancy to late adolescence. We describe the process of maturing with emphasis on the defining Accepted 19 December 2011 features of the Brazilian financial system over the last 20 years: (1) stabilization and the subsequent Available online 25 January 2012 financial crisis; (2) universality of banks; (3) market segmentation through public lending; (4) institutional improvement. Further paraphrasing Diaz-Alejandro (1985), we raise some hypotheses on why, this time, JEL classification: the financial boom has not (at least yet) turned into a financial crash. G21 © 2012 The Board of Trustees of the University of Illinois. Published by Elsevier B.V. All rights reserved. G28 G32 Keywords: Financial repression Financial deepening Stabilization Stability Financial crisis Stability 1. Introduction the years 2000 has not turned into a financial crash, as in many other instances of financial liberalization in the Latin American past Financial intermediation has grown from infancy to late adoles- (Diaz-Alejandro, 1985). The solidity of the Brazilian financial inter- cence since stabilization in 1994, from tight repression to a financial mediation so far is informative for prudential measures in both boom. In 2000, bank credit amounted to 25% of GDP, and market- emerging and mature economies. based lending was trifle, only 15%. Except for occasional spikes, this picture remained unchanged until 2003, when financial inter- mediation started to build momentum, driven by consumer credit. By the beginning of the 2010 decade, credit-to-GDP ratio reached 2. A brief of description of the Brazilian banking system 45%. More importantly, market-based lending drove most of the financial deepening in the years 2000 (see Chart 1). The Brazilian banking industry is a universal bank system com- In this paper we first describe in detail the anatomy of this posed of different types of banks, with diverse ownership structure regime change from financial repression to financial boom. Based (having an important presence of government-owned banks), and on the description of the anatomy, we raise hypotheses about a strong intervention of the federal government, in the form of the causes of financial repression and financial deepening, which prudential regulation (as in most banking systems), price regu- are informative for developing countries in general. We then go lation (not so common), and direct quantity regulation (through 1 one step further and explain why the Brazilian financial boom of earmarked loans). Inasmuch as banking systems are comparable, the Brazilian industry is somewhat similar to Germany’s in terms of structure. ଝ We thank Alessandro Rivello, Bruno Balassiano and Carolina Machado for expert research assistance. ∗ Corresponding author. 1 E-mail addresses: [email protected], [email protected] John Hicks used to compare financial systems to snowflakes or fingerprints, all (M.G.P. Garcia). are very similar but no two are exactly equal. 1062-9769/$ – see front matter © 2012 The Board of Trustees of the University of Illinois. Published by Elsevier B.V. All rights reserved. doi:10.1016/j.qref.2011.12.009 136 J.M.P. De Mello, M.G.P. Garcia / The Quarterly Review of Economics and Finance 52 (2012) 135–153 48% 42% 36% 30% 24% 18% 12% 6% Government F.I. PrivateF.I. Total Source: Brazilian Central Bank Chart 1. Credit (% of GDP). 2.1. The players resources of Fundo de Garantia por Tempo de Servic¸ o (FGTS), 3 the mandatory unemployment insurance fund. 2 Formally, the financial system is composed of : d. Credit Cooperatives. Equivalents of Credit Unions in United States. Typically, credit cooperatives are formed by members of a merchant guild or labor union. They can only receive deposits from cooperative members. These institutions are not 1. Deposit receiving institutions. As the name suggests, these are relevant market players. institutions franchised by the Central Bank (the banking reg- e. Investment Banks. Private financial institutions whose purpose ulator) to receive demand deposits from the general public, is to exclusively finance companies by temporary acquisition although most also receive time deposits (Certificates of Bank of shares and corporate bonds, and providing firms with short Deposits) and savings deposits. They can be privately-owned and long-run loans. They are not allowed to receive time deposits. (both domestic and foreign), or government-owned, at both fed- They are also suppliers of financial services such as underwrit- eral and state levels. They are sub-divided in: ing, financial advising, valuation for Mergers and Acquisitions, a. Commercial Banks. Depository institutions whose main source etc. of funding are demand and time deposits (but are allowed to f. Development Banks. Development Banks are state-owned (i.e., issue commercial paper and borrow in the interbank market). owned by the states, not the federal government) or federally- A distinctive characteristic is that they cannot perform the owned banks whose main function is to make long term functions of investment banks. loans to “development targeted projects”. The most important b. Multiple Banks. These are the equivalent of Universal Banks. development bank is, by far, the Banco Nacional de Desenvolvi- Ordinarily, they are Multi-Bank Holding Companies that per- mento Econômico e Social (BNDES). Because of its importance form both the function of commercial and investment banks. in long-term financing, we dedicate a sub-Section to BNDES All ten largest private banks and the largest government- alone. owned bank are Multiple Banks. c. Caixa Econômica Federal (CEF). The first peculiarity of the Chart 2 shows the market structure of the Brazilian Banking Brazilian banking system. Caixa Econômica is a Federally- System (BBS), considering only commercial banks (public and pri- owned Commercial Bank whose mandate involves (in a rather vate) and CEF. On top of what appears in Chart 2, the National ill-defined way) prioritizing lending and financing projects Development Bank, BNDES, currently provides more than one-fifth and programs in social assistance, health, education, and the of total credit (20.97%). Four important characteristics of the BBS like. It can, however, supply standard banks’ loans, such as emerge from Chart 2. A major part of the system is composed of consumer credit, and working capital. It is enfranchised with several monopolies, such as lending with industrial or per- sonal pawning collateral. More importantly, however, Caixa 3 is a major player in recruiting savings deposits and mort- The FGTS, created in the mid-1960s, substituted the previous employment sta- bility scheme. It is formed by 8% of the gross (pre-tax) wage bill (formal sector, which gage lending. Finally, Caixa is the depository institution of the is about 60% of total employment). Resources are deposited in personal accounts at the Caixa Econômica Federal and can be withdrawn in case of unemployment, to buy houses (the first under someone’s name), and in case of terminal diseases. Annual interest rates on FGTS deposits are regulated at Taxa Referencial (TR) plus 3%. TR is an index computed as the average of 30-day CDs issues by a sample of 30 financial 2 Taxonomies are normally arbitrary. Whenever relevant we emphasize the real institutions with largest issues of CDs. A reduction (redutor) is then applied to this market-based segmentation of banks. average rate. J.M.P. De Mello, M.G.P. Garcia / The Quarterly Review of Economics and Finance 52 (2012) 135–153 137 Chart 2. Market structure by credit assets. “universal” banks: the four main commercial banks – BRADESCO, fraction of some types of deposits must be employed in financing BB, ITAU-UNIBANCO and SANTANDER – are universal banks in the certain sectors (earmarked lending). sense that they all have commercial and investment banking and well as major insurance operations. Together they hold just a little 3.1.1. Direct production in Commercial Banking and Earmarked under 65% of all banking assets. Brazil has a dual banking system, in Credit which public and private commercial banks co-exist. Furthermore, The earmarked credit scheme has several implications for pric- BNDES alone holds almost 21% of all credit assets, as previously ing and competition. First, it increases the marginal funding cost mentioned. As we show below, the dual nature of Brazilian bank- for the banks and thus renders the non-earmarked credit segment ing is not inconsequential for the performance of intermediation. more expensive; this phenomenon has already been documented Finally, the structure is concentrated: the five largest banks (includ- by analysts at the Brazilian Central Bank (e.g., Costa and Lundberg ing CEF) hold 78% of all assets. Concentration suggests (but does not [2004], Costa and Nakane [2005]). Second, the effect on funding cost implie) that competitive conduct may be a problem. for the Banco do Brasil’s non-earmarked loans is strong because 50% of its funding is allocated to the non-earmarked segment. Third, this scheme differentiates BB from private commercial banks as a result 3. Structural determinants of the Brazilian credit market of its focus on a segment that private banks often avoid serving. Dif- performance ferentiation softens competition and thus leads to higher prices. Fourth, Arrigoni, De Mello, and Funchal (in press) provide strong Until the early 2000s, the performance of the BBS was poor both evidence that the presence of government-owned banks softens in terms of quantities and prices.
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