The Brazilian central bank's first benchmark interest rate hike in roughly six years will trigger a gradual increase in lending rates but could also lead to a spike in banks' funding costs, analysts told S&P Global Market Intelligence.
The unanimous March 17 decision by Banco Central do Brasil policymakers to raise the Selic rate by 75 basis points to 2.75% was "more aggressive than the market had been foreseeing," according to Joao Mauricio Rosal, chief economist at São Paulo-based brokerage firm Guide Investimentos.
The decision was driven by heightened inflationary risks and a new wave of COVID-19 infections that could impact economic activity.
The shift in monetary policy could "prove effective in anchoring inflation expectations and supporting the credibility of the central bank," Moody's vice president Samar Maziad said in a statement. However, Maziad warned that amid a worsening pandemic and given the slow pace of vaccination, "higher interest rates add downside risks to economic growth prospects for the rest of the year."
In terms of credit, Guide Investimentos' Rosal noted that rates on consumer loans and credit cards, which have traditionally shown the highest sensitivity to benchmark rate movements, are likely to inch upward this year.
The overall recovery for banks' net interest margins will take more time, however, and will depend largely on whether the central bank extends the duration of measures that have supported loan disbursement during the pandemic, Rosal added, pointing specifically to lower reserve requirements and flexible accounting criteria for loan deferrals.
"These are key measures that are still insulating banks' profitability and margins in the midst of this crisis, and it's not clear at which pace the central bank will unwind them, particularly in light of this new and quite aggressive wave of COVID-19 cases," Rosal said.
Changes in the Selic rate have shown some correlation with banks' net interest margins. As the rate was slashed to a historic low of 2% between 2016 and 2020, the average net interest margin of banking majors Itaú Unibanco Holding SA, Banco Bradesco SA and Banco Santander (Brasil) SA fell to 4.56% from 5.65%.
Funding costs and lending strategies
S&P Global Ratings bank analyst Cynthia Cohen Freue said the rate hike will have a negative impact on banks' cost of funding, which tends to spike before lending rates rise.
"On the lending side, things could take longer, as it's important to note that when the interest rate was lowered last year, banks' loan rates did not adjust as quickly, except for mortgages," she said. "This is also because the cost of credit increased due to the higher risk."
But with banks potentially looking to shuffle their loan mix in 2021 and increase consumer loans in lieu of corporate lending, their spreads should improve overall, Cohen Freue added.
While S&P Global Ratings expects credit growth in Brazil to fall to between 7% and 8% this year from 15.5% in 2020, realizing that forecast would still represent among the strongest expansions in lending in the largest Latin American economies.
A higher Selic rate will also boost lenders' income from investments in securities, which makes the hike "even more relevant for banks that have insurance companies, as these often have high levels of liquidity that they invest in securities," Cohen Freue noted.
In announcing the Selic increase, Brazil's central bank said it will now adopt a "process of partial normalization," with another rate increase of 75 basis points expected at its next monetary policy meeting "unless there is a significant change in the inflation projections or in the risk balance."
