Brazil: Failure demonstrates pressure on small banks

The liquidation of Brazilian bank Cruzeiro do Sul has damaged the reputation of the Brazilian central bank (BCB), and heightened funding difficulties for other small and medium-sized banks, according to market participants.

There has been much debate about the role played by the FGC, the privately held credit-guarantee fund, and its attempts to stave off insolvency, but little comment about the supervision by the central bank.

“The central bank and the securities regulator [CVM] haven’t attracted much criticism, but that’s surprising,” says one banker. “They had been aware that the bank had some accounting irregularities for some time – at least a couple of years – and I don’t know why it took them so long to act.”

The central bank put Cruzeiro do Sul into the hands of the FGC in early June because of a $1.5 billion accounting hole. It is still unclear if fraud is to blame but the suspicion is that the losses are too large to be caused just by sloppy internal accounting procedures.

The delay on the part of the central bank was probably due to its preferred solution of facilitating failing banks’ bailouts by larger participants. The central bank was instrumental in BTG Pactual’s acquisition of PanAmericano after it was found to have been fraudulently double-counting assets into securitization transactions.

Start-up banks also reported that the central bank pressured them to take on failing organizations as a condition of getting banking licences. However, with Cruzeiro do Sul’s losses suspected to be even larger than those stated, a bailout solution was not workable this time, although some see positives from the insolvency.

“Perhaps a benefit from this event to the banking system is that banks will be encouraged to further improve operational procedures and minimize funding gaps, as investors are likely to increase their scrutiny of investment choices knowing that the Brazilian regulators may not bail out investors in the event of future bank failures,” says Fitch Ratings. “The combination of these trends should lead to a stronger and perhaps more consolidated banking system.”

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