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Learning from emerging markets: A Brazilian perspective


31 March 2009

This is one in a series of articles looking at financial regulation and reform.  

With the debate about the future of financial regulation in full swing, it is encouraging for global markets that it is the G20 meeting in London, and not just the G8. 

In trying to strike the right balance between smart regulation and over-regulation, leaders in the U.S. and Europe could do worse than to look at the experiences of the emerging market nations joining them at the table in London.

Brazil is a good example. 

The Brazilian market has for decades been one of the most highly regulated in the world. While this model has been criticized in the past for generating bureaucracy and stunting growth, it has proved to be somewhat of a blessing in the current crisis, allowing regulators to "work with what they've got" and largely avoid radical new rules.

As the U.S. and Europe continue to debate the extent to which governments should exert control over the financial sector, including the merits of outright nationalization of major banks, Brazil – despite President Lula's populist rhetoric – continues to take a measured approach which deserves a closer look. Some examples?

Stimulating lending through bank consolidation

The Brazilian government has for decades played a major and systematic role in the nation's banking sector, controlling major players such as Banco do Brasil, which until last year was the largest full service financial institution in Latin America, Caixa Econômica Federal, Brazil's largest mortgage lender, and Banco Nacional de Desenvolvimento Econômico e Social (BNDES), the state development bank.

Yet at the same time, many privately-owned financial institutions, both large and small, have flourished.

Until recently, government-owned banks required congressional approvals to acquire control or major stakes in private banks, insurers and pension plans, thereby limiting direct government control over additional players in the sector. 
However, in response to the crisis, these takeover rules were relaxed in October 2008, and since then government-controlled banks have either acquired or purchased a major stake in several smaller private banks.

While this could be viewed as a government power grab, the reality is more complex. Unlike the U.S. and some countries in Europe, the Brazilian government is no amateur when it comes to bank management. 

These acquisitions and equity injections have not only been strategic for the government banks' results, but also in terms of economic policy, as the equity investments have given the target banks a much needed source of long-term funding, allowing them to increase lending in priority sectors such as consumer and vehicle finance.

Furthermore, the government has chosen not to block mergers between major privately-held banks on anti-trust grounds – including the recent Banco Itaú-Unibanco merger, which created the largest financial institution in Latin America, surpassing Banco do Brasil.

In other words, while government-controlled banks have been allowed to expand strategically, the private sector is not drying up.  At the same time, this wave of consolidation has contributed to the ability of the sector as a whole to respond to the crisis, and the government has had some success in encouraging banks to pass along lower interest rates to borrowers.

Regulating derivatives

In stark contrast to the U.S. and Europe, Brazil's approach to the regulation of derivatives has historically been highly restrictive.

Brazilian regulations require that derivatives transactions be registered, and that clearing systems must be recognized by the Brazilian authorities – a system which looks a lot like the broad outline of new derivatives regulations presented just recently by U.S. Treasury Secretary Geithner.

While these rules have created a more transparent market than those in the U.S. and Europe, they still proved insufficient in preventing several major Brazilian companies from incurring heavy losses on speculative foreign exchange derivatives trades.

In response to this, the Brazilian securities regulatory authority, the Comissão de Valores Mobiliários (CVM), recently adopted rules which significantly increase the level of disclosure required of public companies in respect of their derivatives transactions.

In addition to other detailed information, public companies must disclose "sensitivity analyses" which detail the pro forma effects on the company's results of hypothetical 25% and 50% losses on its derivatives contracts.  Additional regulations are expected this year.

After years of looking to the U.S. SEC as the benchmark example in crafting its disclosure rules, Brazil is now choosing its own way in improving the disclosure of derivatives.  This would certainly be worth discussing in London.
Asset origination.

In addition to direct government regulation, Brazilian self-regulatory organizations have also adopted rules that target certain of the root causes of the economic crisis.

For example, the National Association of Financial Market Institutions (ANDIMA) recently amended its model code of ethics in an effort to ensure the quality of promissory notes originated by its member financial institutions. 
As these promissory notes can be pooled and securitized, originators who have adopted the ANDIMA code of ethics, which include major players in the Brazilian market, must take concrete steps to ensure the quality of the assets.

For example, originators must ensure that all borrowers meet that institution's full risk, compliance and credit criteria (i.e., they are reasonably likely to pay off the loan), and sales of notes may only be made to sophisticated purchasers. 
Furthermore, purchasers may not rely on ratings alone as sufficient evidence of credit quality.  In other words, the lack of controls which led to the sub-prime mortgage crisis in the U.S. are being directly addressed.


If the economic crisis has taught us anything, it is that no regulatory system is perfect. Each country must find its own way, but we must work together to ensure consensus on some very controversial points.

The G20 summit is an opportunity for real give and take between the developed and emerging markets, and British Prime Minister Brown's visit to Brazil and Chile last week is a good sign that all G20 countries will be expected to bring something to the table.

Furthermore, the broad-brush regulatory "rules of the road" proposed this week in the U.S. show that the developed markets are becoming both more serious and more specific about tighter regulation.

The Brazilian experience offers us a glimpse through the window at what a new system may look like – its successes, but also its failures. The U.S. and Europe will be missing a great opportunity if they don't take a look.

Further information

View the webcast: Philip Wood on what really caused the financial crisis and what needs to happen now.


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