Brazil finance minister Paulo Guedes didn't mince words. During a recent congressional hearing, he called the country's banking federation, Febraban, and its largest banks a "cartel" that charged "absurd" interest rates on loans. He vowed to break their stranglehold.
The impending introduction of open banking in Brazil could represent his last, best hope of doing that.
To be sure, Guedes and others have long criticized the lack of competition in Brazil's banking industry. The country's five largest banks hold about 80% of financial system assets, and interest rates for many credit products remain high.
Annual credit card rates can still top 160% in Brazil; rates on personal loans sit near 70%, though that's down from about 100% earlier this year. By contrast, the benchmark Selic rate is at a record low 2%; and the central bank's inflation expectations for this year and next are just above 3%. The wide spread between those rates have helped Brazil's banking industry become one of the most profitable in the world.
Taken together, "regulators are being extremely favorable to disruptors," said Paulo Passoni, a Latin America-focused managing partner with Softbank, which has earmarked $5 billion for investment into the region's technology sector.
"Banking spreads in Brazil are an anomaly ... [It] has to do mostly with one condition: the oligopoly, an imperfect banking system when it comes to competition," said Fernando Ribeiro Leite, an economist with Insper business school in Sao Paulo.
In an effort to narrow the gap, the central bank on Nov. 30 will begin the first stage of a yearlong implementation process toward open banking. The move aims to reduce data asymmetry and provide financial technology firms and new entrants easier ways of pricing credit by allowing financial records to flow freely.
The move to open banking comes on the heels of a major mobile payments initiative, called PIX, which will invite greater competition in the transactions space and could pressure banks' fee income.
"These things are really accelerating market share loss of the largest banks," Antonio Bernardo, a partner at Roland Berger, noted. Bankers already have acknowledged an impact on their acquiring and investment verticals. Now, analysts expect credit spreads to ease as well, albeit at a gradual pace.
"PIX and open banking are the system's last chance to intimidate big banks into driving rates down," Luis Santa Creu, a bank analyst with Austin Ratings, said.
The average spread a private bank earned on a loan in Brazil has already contracted by about a third over the course of 2020. That has translated to lower bank returns as well. At Itaú Unibanco Holding SA, the country's largest private bank, ROE fell to 15.7% in the third quarter from 23.5% a year earlier; at Banco Bradesco SA it dropped to 15.2% from 20.5%.
But analysts attribute the compression seen so far mainly to banks' shift towards lower risk lending amid the COVID-19 pandemic.
"There is a medium term trend to push margins down, but as of now the greatest driver is changes in the mix," said Cynthia Cohen Freue, a bank director with S&P Global Ratings. Over the long term, however, she maintains that "historical returns are going to be ever more difficult to achieve."
Bank executives already are bracing for that eventuality. A growing number of financial technology companies, unencumbered by the expense of branch footprints and large staffing numbers, are moving into the space, offering more attractive rates to customers.
"The general trend in financial services is a commoditization of products and a reduction in spreads as technology solves problems," said Sergio Furio, CEO of Creditas Soluções Financeiras Ltda., one of the largest fintechs in Brazil. "In 10 years' time, bank spreads will have gone down from 30% to around 10%."
Furio noted that such shifts already happened in markets throughout Europe and in the U.S. Now, it is beginning in Brazil.
In order to maintain profit levels, a Roland Berger study calculated that big private banks in Brazil, including Banco Santander (Brasil) SA, Banco do Brasil SA and Caixa Econômica Federal, will need to cut some 30 billion reais in costs over the next three years.
"The reduction in spreads will increase cost-cutting pressure for banks in order to retain profitability," Roland Berger's Bernardo said. Much of those cuts likely will come by way of branch closures. Furio, the Creditas CEO, expects that customer usage of physical branch locations "will fall by more than 50% in the post-pandemic world."
The major banks are now working more aggressively to those ends. Some have stepped up their pace of branch closures during 2020 and are working to reduce expenses elsewhere.
But even with those cuts, "the pure banking business will have an inexorable downward trend on its return on equity," Furio said. "There is no turning back."