We would like to ensure that you are still receiving content that you find useful – please confirm that you would like to continue to receive ILO newsletters.
16 April 2004
Defining Trends and Challenges
Regulatory Agency and Legal Framework
Equity Interests of Existing Investors
Additional Approvals for Transfers of Control to Non-Brazilian Buyers
Trends in Limitations on Non-Brazilian Shareholdings
Capital Adequacy Ratios
The Brazilian banking industry faces evolving challenges as it adapts to changing economic conditions, including a gradual reduction in real interest rates and increasingly stable foreign exchange markets. The defining trends of the last decade continue to dominate the agenda for Brazilian financial institutions. These trends are:
Consolidation has been intense since the mid-1990s, when a series of bank failures ensued as a result of the end of hyperinflation, and international banks entered the market to acquire distressed assets under the banner of re-establishing the soundness of certain target banks. Domestic banks reacted by seeking greater scale. Between 1994 and 2002, 46 banking acquisitions took place. The market share of government banks plunged as the Brazilian federal government took action to promote the privatization or liquidation of financially frail state government-owned banks. Nevertheless, the two largest banks remain government-owned and the National Development Bank remains the preferred credit provider for domestic borrowers.
In roughly the same period, non-Brazilian controlled banks grew significantly, increasing their share of aggregate banking assets from 8.7% in December 1993 to 30.4% in June 2002. The banking sector is still dominated by domestic banks, however, as only three of the largest 10 banks, as measured by total assets, are non-Brazilian controlled.
In the regulatory arena, the Brazilian government and the Central Bank continue to press for greater availability of credit and the reduction of banking spreads. While the total assets of Brazilian financial institutions represent approximately 160% of gross domestic product (GDP), bank loans represent only 30% of GDP. Both indicators denote a significantly smaller credit market than those in countries having a comparable tradition of relatively strong banking sectors and weak capital markets. The scarcity of credit has not prevented banking spreads from reaching high levels. These two factors have attracted intense political attention as the government sought to boost economic growth by reducing the target for the benchmark interest rate to 16% as of April 2004. The Central Bank is actively targeting banking spreads as part of its policy to engage in microeconomic reform aimed at reducing market imperfections that have resulted in the scarcity of bank loans.
The typical functions of a Central Bank are exercised primarily by the National Monetary Council, which is comprised of the minister of the economy, the minister of planning, budget and management and the president of the Central Bank (Article 8, Law 9069/1995, as amended). The regulations issued by the National Monetary Council are executed and enforced by the Central Bank. In practice, the Central Bank sets the agenda for most regulations affecting the banking and financial industry as a whole. The Brazilian Securities Commission regulates capital markets and certain other matters, and other financial regulatory agencies are entrusted with the regulation of insurance and pension funds.
The most active self-regulatory organization is the National Association of Investment Banks, which has adopted codes of best conduct with respect to public offerings of securities and the management of investment funds that are mandatory for affiliated investment banks. The National Association of Investment Banks monitors compliance and has issued penalties ranging from private reprimands to expulsion from the association.
Basic elements of the legal framework
Federal Law 4595/1964 grants wide-ranging powers to the National Monetary Council and the Central Bank with respect to monetary policy, the regulation of foreign exchange transactions, credit policy and the regulation of financial institutions. In practice, National Monetary Council and Central Bank regulations are detailed and exhaustive, and form the bulk of regulations requiring ongoing compliance. The Central Bank publishes and regularly updates sets of consolidated regulations that cover most of the principal regulatory subject matters, including a Restatement of Foreign Exchange Regulations, which covers all regulations relevant to foreign exchange transactions, and a Manual of Rules and Directives, which includes:
Legislation enacted in October 2001 and effective as of February 2002 transferred regulatory powers with respect to certain financial products from the Central Bank to the Securities Commission (specifically including derivatives, futures and commodity exchanges, clearing houses for transactions involving securities and investment funds). The Securities Commission and the Central Bank have acknowledged that some of these matters have implications for the monetary, credit and economic policies administered by the Central Bank, and have put in place arrangements to share information, engage in consultations prior to taking regulatory actions and consult on matters implicating the jurisdiction of each regulator, with a clear emphasis on the need to preserve the Central Bank's ability to carry out its policies (Convênio of July 5 2002). Notwithstanding this limitation on the scope of its powers, the National Monetary Council and the Central Bank are still the principal regulators of financial institutions in Brazil.
A licence is required from the Central Bank to operate a financial institution in Brazil. There are no licensing options available specifically to non-Brazilian financial institutions. Under applicable regulations and in accordance with the commitments of the government under the General Agreement on Trade in Services, non-Brazilian entities are afforded national treatment regarding the establishment and licensing of financial institutions, except for the requirement of specific approval from the president as detailed below.
The National Monetary Council has issued licensing regulations (National Monetary Council Resolution 3040/2002) that govern the establishment, licensing, transfer of control and corporate restructuring of financial institutions, as well as the cancellation of authorizations granted to financial institutions. Only certain credit cooperatives and other companies fall outside the scope of these regulations.
The regulations adopt a three-stage licensing process, including a final monitoring stage, in which ongoing compliance with certain aspects of the proposed operating plans are intended to be assessed with the aid of independent auditors. Additionally, the regulations list certain transactions requiring prior approval or notification of the Central Bank.
First stage - presentation of operating plan and other commitments
The first stage of the licensing process under the regulations comprises the publication of a statement of intent containing such disclosure as may be required by the Central Bank, and the presentation of a detailed operating plan containing:
The applicant must identify a project officer and an organizing group that will be in charge of the application. The organizing group must include representatives of the controlling shareholders and any significant shareholders. 'Significant' shareholders are defined as holders of 5% of equity in the applicant.
The applicant must disclose the members of the group of controlling shareholders, the shareholding structure and the arrangements relating to control. In addition, the controlling group and significant shareholders will be required to consent to the sharing of financial information between the Federal Tax Revenue Department and the Central Bank. Proposed officers and directors may also be required to consent to the sharing of information with tax authorities.
The applicant must also produce evidence that the financial condition of the group of controlling shareholders is adequate to support the proposed operations. The Central Bank may require a demonstration of financial strength from a controlling shareholder or from the group of controlling shareholders, depending on the circumstances.
The regulations apply independently from existing regulations establishing ongoing capital adequacy requirements for financial institutions. Nevertheless, they encompass a flexible standard for assessing the overall financial strength of the controlling group, including significant shareholders. In adopting this approach, the regulations abandoned the approach of previous bright-line rules for financial soundness of controlling shareholders that were based on specific, quantifiable financial soundness requirements for controlling shareholders.
The Central Bank has indicated that it will rely on all available information to determine whether the financial condition of the applicant and its shareholders is sufficiently sound.
The Central Bank will also seek assurances that the controlling and significant shareholders are reputable. Such assurances will usually take the guise of representations that they have not been:
The Central Bank will nevertheless take into account any facts that may impeach the integrity of shareholders, proposed directors or proposed officers.
Second stage - request for authorization
The applicant must submit a request for authorization within 90 days of the date of approval of the business plans and disclosures made by the applicant, controlling and significant shareholders, and proposed officers and directors. The Central Bank may grant an extension of an additional 90 days at its discretion, if requested by the applicant.
Conceptually, the first stage of the licensing process is designed to allow the Central Bank to consider the proposal for the establishment of a financial institution. During the second stage, the applicant will incorporate the financial institution, contribute capital as required to meet the minimum paid-in capital requirements, and appoint its directors and officers, in preparation for the grant of an authorization to operate.
The Central Bank will grant authorization after it has approved the constitutive documents of the applicant, which must comply with applicable regulations. Typically, these regulations are specific to each type of financial institution and generally provide for requirements relating to:
The group of controlling shareholders and the significant shareholders will also be required to identify the sources of the funds intended to be used to capitalize the financial institution as a condition to the receipt of an authorization from the Central Bank.
Third stage - beginning of operations and monitoring
Upon receiving authorization, the applicant must begin its operations before the deadline established in its business plan. Prior to beginning its operations, the officers and directors of the financial institution must certify that its facilities conform with the business plan and that it has acceded to the relevant deposit insurance mechanism and any other existing investor protection programme under applicable regulations.
For three years after the beginning of operations, the financial institution must include an assessment of actual operations in its annual report, stating whether they conform to the representations made in the business plan and submitted to the Central Bank with respect to the strategic objectives for the business. The reports must be reviewed by independent auditors. The Central Bank must be informed of any lack of compliance and may require corrective action within a reasonable period of time or revoke the authorization to operate as a financial institution.
'Universal banks' are denominated multiple banks in Brazilian regulatory terminology. The licensing procedures for multiple banks are the same as those applicable to other financial institutions. Multiple banks must have two of the following four portfolios:
Most major Brazilian banks are multiple banks that also have affiliated insurance companies and offer (directly or indirectly) the full range of financial services. In June 2003 there were 189 licensed banks in Brazil, including 139 multiple banks.
International banks may establish a financial institution in Brazil, but may not operate without proper licensing as a Brazilian financial institution. In establishing a financial institution, non-Brazilian entities are afforded national treatment except for the requirement of specific presidential approval, which must be sought in accordance with the same procedures described below.
Under Brazilian law, there are no restrictions on ownership of a banking business,
other than those regarding:
The Central Bank will require a showing of financial soundness adequate for the business of the financial institution, and may look to the financial condition of each or all of the controlling and/or significant shareholders. No bright-line rules are established by the Central Bank, although prior practice and precedents afford some guidance.
Documentation requirements with respect to controlling shareholders include: (i) evidence of financial soundness of direct and indirect controlling shareholders; and (ii) lack of evidence of wrongdoing or disreputable conduct by controlling shareholders and management.
Both controlling and significant shareholders are considered during the licensing process.
Significant shareholders must:
Corporate form of controlling shareholders
The licensing regulations restrict the kinds of persons, including corporate entities, that may control financial institutions. Only the following may control a financial institution, whether directly or indirectly:
Authorization for transfer of control or corporate event
Under the regulations, any transfer of control and certain corporate events of a financial institution must be authorized in advance by the Central Bank.
'Transfer of control' is defined broadly to include any event directly or indirectly affecting a member of the group of controlling shareholders, including the execution of a shareholders agreement, any transactions conducted by any person or group of persons acting in concert, and any other transfer, regardless of whether it is voluntary. No transfer of control is deemed to occur as a result of an event that will not affect the management of the business of the financial institution. Transfers may be made among corporate entities that are under the ultimate control of the same group of individuals.
Corporate events that require prior approval include:
Mergers, spin-offs or consolidations at the parent company level will be deemed to be a transfer of control and will therefore require prior approval.
The Central Bank requires parties to a transfer of control transaction to provide documentation explaining the strategic, corporate, financial and tax objectives. When considering requests for the prior approval for transfers of control or corporate events, the Central Bank may request any of the disclosures, representations or commitments required of an applicant for authorization to establish a financial institution. In addition, the bank may request that the acquirer identify the source of the funds intended to be used to acquire control. The Central Bank has issued directives stating that it will not authorize the transfer of control of financial institutions that have failed to comply with certain ongoing obligations relating to reporting, operational standards or the payment of fines.
The following increases must be communicated to the Central Bank:
The Central Bank may request: (i) information regarding the financial strength of the acquiring person and the source of funds used to acquire the additional equity interests; and (ii) consent to the sharing of financial information between the tax authorities and the Central Bank.
An authorization for the transfer of control of a financial institution to non-Brazilian persons or the increase in the equity interests of non-Brazilian persons in financial institutions is subject to presidential approval. The process for obtaining such approval begins with a review of the request by the National Monetary Council, which may recommend that the president authorize the purchase by decree on the basis of a discretionary assessment of national interest.
The National Monetary Council has full discretion in making its recommendation and the president enjoys similar discretion in deciding whether to grant the authorization. The procedures are set out in Article 52 of the Transitional Constitutional Provisions Act and in Explanation of Reasons 331/1995 of the Ministry of Finance.
Only after the presidential decree has been obtained will the parties be eligible to proceed with requests for prior approval for transfers of control under the licensing regulations and to submit notifications of any increase in equity interest.
The legal framework for non-Brazilian investment in the domestic financial market continues to afford the government broad discretion to approve or reject any investment by non-Brazilian persons in a financial institution. There are no legal impediments to prevent the government from reversing its declared policies and curtailing the access of non-Brazilian investors to the domestic financial market.
Accordingly, as a procedural matter, the specific approval of the president can be sought by a relatively streamlined process in which the National Monetary Council has a commanding role, as described above. Ultimately, in order to consummate an acquisition or investment, non-Brazilian investors need to rely on the government's discretionary policies. Public declarations by the Central Bank and government officials have not suggested any significant change in a generally liberal stance regarding market access.
Minimum paid-in capital requirement
The minimum paid-in capital requirement varies in accordance with the type of financial institution, its location and its number of branches.
The following table sets out the minimum paid-in capital requirements of certain types of financial institutions:
|Type of Financial Institution||Minimum Paid-in Capital Requirement||Requirement if Head Office and 90% of Branches are Located Outside Rio de Janeiro or São Paulo|
|Commercial bank||R17.5 million||R12.25 million|
|Investment bank||R12.5 million||R8.75 million|
|Leasing company||R7 million||R4.9 million|
|Real estate financing company||R7 million||R4.9 million|
|Mortgage financing company||R3 million||R2.1 million|
|Broker/dealer (including asset management activities)||R1.5 million||R1.05 million|
|Multiple bank (must have at least two of the following lines of banking business)|
|Commercial bank||R17.5 million||R12.25 million|
|Investment bank||R12.5 million||R8.75 million|
|Real estate financing company||R7 million||R4.9 million|
|Retail financing company||R7 million||R4.9 million|
|Leasing company||R7 million||R4.9 million|
|Total (Lowest minimum capital requirements for each combination of businesses)||Between R14 million and R30 million||Between R9.8 million and R21 million|
The minimum paid-in capital requirement is increased by R6.5 million for all financial institutions that transact in foreign exchange markets.
The National Monetary Council and the Central Bank have adopted regulations inspired by the 1988 Basel Accord that establish a minimum capital requirement based on risk-weighted assets and other factors. Generally, the capital requirement is the aggregate of at least 11% of the risk-weighted assets and additional components for exposure to interest rate risk, foreign exchange risk and derivatives risk.
The capital base of a financial institution comprises Tier 1 and Tier 2 capital, as defined by regulations issued by the Central Bank. Brazilian financial institutions must have regulatory capital that meets the capital requirement.
Capital requirement comprises four key components:
As of June 30 2003 the capital requirement of the average Brazilian financial
institution was composed of:
The multidimensional determinants of the capital requirement are intended to apply a risk-focused capital adequacy requirement that is more flexible and responsive to a financial institution's specific risk profile. The risk-focused approach to capital requirements is also evidenced by the use of credit risk analysis in weighting assets under the traditional, risk-weighted asset component of the capital requirement.
The National Monetary Council and Central Bank have adopted regulations that limit the ability of financial institutions to invest in fixed assets (so-called 'permanent assets' under Brazilian accounting principles) to 50% of an adjusted version of the capital requirement of financial institutions.
Other regulations limit the foreign exchange exposure of financial institutions to 30% of their regulatory capital. In late 2002 the level of permitted exposure was lowered from 60% to the current level of 30% in response to growing volatility and accelerating depreciation of the real in foreign exchange markets. The foreign exchange exposure is defined to include exposure to variations in the price of gold and other assets, and liabilities denominated or indexed to foreign exchange.
Recently, the rules for the settlement of financial transactions through payment systems have undergone drastic changes as financial institutions have made the transition to radically new systems.
In 2002 the Central Bank commenced the transition to real-time gross settlement in designated payment systems. Real-time gross settlement aims to comply with the Core Principles for Systematically Important Payment Systems set out by a taskforce of the Bank for International Settlements (CPSS Publications 43, January 2001) and with the Recommendations for Securities Settlement Systems published by the International Organization of Securities Commissions. As a result of the introduction of real-time processing of transactions, the Central Bank no longer runs the credit and liquidity risks of financial institutions that participate in certain payment systems.
Under the previous regulations, settlement on the major payment system occurred at 11:00pm each business day. If a participant was unable to meet its settlement obligations, the Central Bank could either (i) offer credit to the fragile institution with little hope of recovery (and ultimately incur the loss accumulated during the day), or (ii) refuse to settle the transactions during the day and risk upsetting the entire system.
In contrast, real-time gross settlement transfers the credit and liquidity risks to the participants and operators of the payment systems.
The change in legislation and regulations has not only altered the payment systems practice, but also addressed significant legal issues and uncertainties surrounding payment systems. Under the new rules, the assets used for settlement purposes will no longer be subject to bankruptcy or liquidation proceedings initiated against an insolvent institution. Consequently, transactions settled using amounts or collateral deposited with a clearing house are free of the legal risk of claims of fraudulent transfer and attempts to void and reverse payments by the insolvent entity. Multilateral netting is also now permitted.
Presently, all significant funds transfer systems must settle on a real-time basis. Other payment systems may take up to three working days.
Settlement is effected against accounts that must be held with the Central Bank. Banks may use mandatory reserve accounts held at the Central Bank for settlement purposes.
For further information on this topic please contact Daniel Calhman de Miranda at Mattos Filho, Veiga Filho, Marrey Jr e Quiroga Advogados by telephone (+55 11 3147 7787) or by fax (+55 11 3147 7770) or by email (firstname.lastname@example.org).
The materials contained on this website are for general information purposes only and are subject to the disclaimer.
ILO is a premium online legal update service for major companies and law firms worldwide. In-house corporate counsel and other users of legal services, as well as law firm partners, qualify for a free subscription.