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Summary of Brazil Diversified Banks Report

Core Content

The report analyzes the impact of Brazil's new asset quality reporting regulations, specifically Regulation 4.966, which became effective in January 2025. This regulation aligns Brazil with IFRS 9, introducing an Expected Credit Loss (ECL) model for financial institutions. The goal is to improve the timeliness and accuracy of asset quality indicators, enabling better risk management and more informed decision-making by banks and investors.

The regulation also introduces complementary Resolution 352, which mandates the use of proprietary risk modeling and discretionary inputs in assessing credit risk and expected losses. While this enhances detail, it also introduces challenges in inter-bank comparability.

Main Points and Key Metrics

1. Asset Quality and ECL Model

• Banks must transition to the ECL model, which requires earlier recognition of credit losses.
• The long-term aim is to improve asset quality by providing more timely indicators of credit deterioration.
• The new model is more complex and less standardized compared to the previous incurred loss approach.

2. Key Metrics to Monitor

• Stage 2+3 as % of total loans: Indicates the proportion of loans with potential credit problems.
• Stage 2+3 creation as % of total loans: Measures the speed of asset quality deterioration.
• Stage 2+3 / 90d NPLs ratio: A higher ratio implies better management of problematic assets.
• Coverage of Stage 2+3 loans: Reflects the adequacy of provisions for potential credit losses.

3. Bank Performance in 1Q25

• NU has the highest proportion of Stage 2+3 loans in personal loans and credit cards.
• ITUB has the lowest Stage 2+3 loans.
• BBAS, BBDC, and INTR also exceed the 10% threshold for Stage 2+3 loans.
• ITUB shows the most conservative approach in Stage 3 coverage, while INTR and NU have the lowest.
• BBAS leads in Stage 3 coverage, indicating better preparedness for credit deterioration.

4. Transfers Between Stages

• Banks that allow transfers between stages provide clearer trends in asset quality.
• NU and BPAN show significant transfers from Stage 2 to Stage 3.
• NU also experiences notable reversals from Stage 3 to Stage 2.

Implications of Regulation 4.966

1. Short-Term Effects

• Front-loading of credit losses may temporarily reduce reported capital and earnings.
• Banks need to adjust their provisioning strategies and capital planning to comply with the new rules.

2. Mid to Long-Term Effects

• The regulation aims to reduce procyclicality in the credit system by avoiding large swings in credit losses during economic downturns.
• It encourages more responsive risk appetite and transparent risk modeling.

3. Competitive Advantage

• Advanced risk modeling and data infrastructure could become a new competitive advantage.
• Banks with better data governance and analytical capabilities may optimize capital allocation and improve risk-adjusted returns.

Strategic Considerations

• Revenue recognition under IFRS 9 has evolved, requiring the use of the effective interest method.

• Fees that are integral to the interest rate (e.g., origination fees) are amortized over the expected life of the instrument.

• Other fees (e.g., servicing, syndication) are accounted for under IFRS 15.

• Banks may need to adjust portfolio mixes and focus on high net interest income credit lines.

• Collateralized credit could play a key role in maintaining stable delinquency levels and enhancing profitability.

Transparency and Communication

• With the introduction of more complex and discretionary risk modeling, transparency becomes critical.
• Clear communication of provisioning methodologies, operational risk capital calculations, and DTA changes is essential for maintaining trust with investors and regulators.
• Cross-report reconciliation can further enhance market confidence.

Appendix Summary

• Companies Mentioned:

  • Banco do Brasil (BBAS3.SA)
  • Banco PAN (BPAN4.SA)
  • Bradesco (BBDC4.SA)
  • Inter & Co Inc (INTR.N)
  • Itaú Unibanco (ITUB4.SA)
  • Nu Holdings Ltd (NU.N)
  • Santander Brasil (SANB11.SA)

• Analyst Certification and Disclosures are included in Appendix A-1, highlighting potential conflicts of interest due to Citi's business relationships with covered companies.

Conclusion

Regulation 4.966 introduces a more sophisticated and forward-looking approach to asset quality reporting in Brazil. While it enhances the accuracy and timeliness of credit loss recognition, it also complicates inter-bank comparability. The regulation encourages investment in data and technology, dynamic risk appetite, and transparent communication. These changes could lead to strategic shifts among banks, with larger institutions potentially gaining an edge due to better modeling capabilities.