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Brazil's private banks show ample loss absorption capacity in Fitch stress test


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Brazil's private banks show ample loss absorption capacity in Fitch stress test

Large private banks in Brazil would be able to absorb a one-off additional provisioning of about 140 billion Brazilian reais without breaching 2017 minimum capital ratio requirements, the results of an asset quality stress test conducted by Fitch Ratings showed.

That figure is equivalent to a 2.0x increase in current outstanding provisions for big private banks, meaning they would be able to accommodate a sudden deterioration in provision costs of about 200%.

However, "such a scenario is unlikely even under a sharp macroeconomic deterioration and is not our base case," the rating agency noted, adding that under central bank rules, provisions usually tick higher gradually as long as banks downgrade problematic loans.

The stress scenario assumed a 100% credit loss event, beginning with lower rated borrowers and increasing to better quality counterparties, until the capital cushion would be fully consumed by credit losses. At this point, final credit losses would reach 22% of total exposures — 9.0x higher than the average over the past seven years.

The stress scenario does not assume any income from recovered loans, which has ranged from 18% to 24% of final losses over multiple economic cycles, and also excludes any potential benefit from highly collateralized loans.

Additionally, Fitch found that large private banks would show a Tier 1 equity capital cushion of 93 billion reais under Basel III requirements, which are due to be phased in by 2019. "This would still be enough to absorb a one-off loss of 14% and would represent an increase of 2.4x in the banks' current balance of reserves based on June 2017 data," the rating agency said.

Brazilian banks' loss absorption capacity has increased recently due to limited credit growth and a contraction in risk-weighted assets. Fitch expects Brazilian banks to maintain robust capitalization amid the phase-in of the Basel III regulatory framework.

As of Oct. 16, US$1 was equivalent to 3.16 Brazilian reais.