PUBLIC BANKS THE BRAZILIAN EXPERIENCE LATIN AMERICAN FINANCE NETWORK BUENOS AIRES – DECEMBER 2003

PUBLIC BANKS THE BRAZILIAN EXPERIENCE INTRODUCTION THE REAL PLAN PUBLIC BANKS AT THE STATE LEVEL PUBLIC BANKS AT THE FEDERAL LEVEL BENEFITS TO THE FINANCIAL SECTOR LESSONS LEARNED

PUBLIC BANKS THE BRAZILIAN EXPERIENCE: INTRODUCTION Beginning of the 90’s – Major participation of public banks in the banking system – Different regulation and supervision for public banks – Implicit government deposit insurance – Poor management practices – High inflation leading to high profits in the banking system – in 1993 inflationary income in the banking system reached 4.2% of GDP – public banks captured 63% of this amount

PUBLIC BANKS THE BRAZILIAN EXPERIENCE: THE REAL PLAN Effects of the Real Plan in the banking system – Loss of inflationary income – High and volatile interest rates – High reserve requirements – Diversification of activities as a means to generate profits leading to high losses in the loan portfolio

PUBLIC BANKS THE BRAZILIAN EXPERIENCE: THE REAL PLAN Need to restructure the banking system Three different approaches to three different problems – Program of Incentives for Restructuring and Strengthening the National Financial System - PROER – Program of Incentives for the Reduction of States’ Participation in the Banking System - PROES – Program for the Strengthening of the Federal Financial Institutions - PROEF

PUBLIC BANKS THE BRAZILIAN EXPERIENCE: PUBLIC BANKS AT THE STATE LEVEL Objectives of the Program: – Reduce state government participation in the banking system – Fiscal restructuring at state level Characteristics of the program: – 100% long-term financing by the federal government, in the case the state government decided to privatize, close or convert the bank into a development agency – 50% long-term financing by the federal government, in the case the state government decided to keep the bank – Privatization proceeds to amortize debt

PUBLIC BANKS THE BRAZILIAN EXPERIENCE: PUBLIC BANKS AT THE STATE LEVEL Three steps to implement the program: – 1st Step Preliminary discussion with the state government representatives to determine the state’s option – 2nd Step Full scope examination of the bank by the supervisory area of the Central Bank of Brazil to determine the net worth of the bank and the amount of financing needed to clean the balance sheet

PUBLIC BANKS THE BRAZILIAN EXPERIENCE: PUBLIC BANKS AT THE STATE LEVEL Three steps to implement the program: – 3rd Step Contracts and approval by the Senate Follow-up by the supervisory area of the adjustments on the balance sheet as soon as bank was capitalized Monitoring of the financial condition of the bank up to the end of the process (privatization, extinction or conversion into non-financial institution)

PUBLIC BANKS THE BRAZILIAN EXPERIENCE: PUBLIC BANKS AT THE STATE LEVEL Results of the program: – Number of banks in 1996 – 35 – Remaining banks at the end of 2003 – 12 Of which: – 4 are in the process of being privatized – 5 were restructured – 3 were not included in the program – 16 development agencies were authorized

PUBLIC BANKS THE BRAZILIAN EXPERIENCE: PUBLIC BANKS AT THE STATE LEVEL Results of the program: – Public banks are now subject to the same supervisory procedures that apply to private banks – Public banks now comply with the same prudential regulation that apply to private banks – Improvement of internal controls and corporate governance structure

PUBLIC BANKS THE BRAZILIAN EXPERIENCE: PUBLIC BANKS AT THE STATE LEVEL Cost of the program: – R$ 60 billion – equivalent to 5.7% of GDP – Privatization proceeds up to end of 2003 – R$ 11.5 billion

PUBLIC BANKS THE BRAZILIAN EXPERIENCE: PUBLIC BANKS AT THE FEDERAL LEVEL Objectives of the Program: – Compliance with prudential regulation – Competition, transparency and efficiency Characteristics of the program: – Transfer of credit risk to the Treasury or a Special Purpose Company – government-oriented loans – Exchange of assets with low liquidity and low interest rate for other instruments accruing market rates – Capitalization of the banks

PUBLIC BANKS THE BRAZILIAN EXPERIENCE: PUBLIC BANKS AT THE FEDERAL LEVEL Three steps to implement the program: – 1st Step Full scope examinations in the federal banks to assess: – Quality of assets – Adequacy of loan classification and provisions for loan losses – Capitalization needs – Organizational structure – Operational policies – Quality of internal controls

PUBLIC BANKS THE BRAZILIAN EXPERIENCE: PUBLIC BANKS AT THE FEDERAL LEVEL Three steps to implement the program: – 2nd Step Federal Government, as the controlling shareholder, requested to present to the Central Bank of Brazil a plan to restructure the banks with the objective of complying with prudential regulation, specially capital adequacy rules In the meantime, disclosure of bad assets and necessary capitalization on the publication of the balance sheet Approval of the plan by the supervisory area of the Central Bank of Brazil Federal Government launched the program in June 2001

PUBLIC BANKS THE BRAZILIAN EXPERIENCE: PUBLIC BANKS AT THE FEDERAL LEVEL Three steps to implement the program: – 3rd Step Follow-up by the supervisory area on action plans presented by the banks on improvement of internal controls and management information systems Follow-up on the recommendations for better corporate governance structure Assessment of credit classification models and follow up on necessary improvements Assessment of risk management structures and recommendations for improvement

PUBLIC BANKS THE BRAZILIAN EXPERIENCE: PUBLIC BANKS AT THE FEDERAL LEVEL Results of the program: – Federal banks complying with prudential regulation and subject to the same supervisory procedures applied to private banks – Improvement on the quality of capital, internal controls, management information systems, risk management structure and corporate governance structure – Banking supervisors doing their job

PUBLIC BANKS THE BRAZILIAN EXPERIENCE: PUBLIC BANKS AT THE FEDERAL LEVEL Total cost of the program - R$ 62.4 billion Increase in Treasury Debt – R$ 12.2 billion

PUBLIC BANKS THE BRAZILIAN EXPERIENCE: BENEFITS TO THE FINANCIAL SECTOR Strengthened banking system more resilient to crisis Enhanced transparency in public accounts

PUBLIC BANKS THE BRAZILIAN EXPERIENCE: LESSON LEARNED More than one option to deal with weak public banks Strong supervision needed Persuasion of key stakeholders of the need for changes Stakeholders’ perception of the value of changes Support by government officials

PUBLIC BANKS THE BRAZILIAN EXPERIENCE TEREZA CRISTINA GROSSI TOGNI