Source: Moody

On 1 March, Brazil’s government announced a five-percentage-point increase on financial institutions' social contribution rates on net income (CSLL) beginning 1 July until the end of this year. Banks' CSLL rates will increase to 25% from 20%, while insurance companies' and credit cooperatives' CSLL rates will rise to 20% from 15%. The rates will return to their original levels on 1 January 2022.

The temporary increase is credit negative for Brazilian banks and credit cooperatives because higher taxes will pressure bottom-line results, and risk negatively affecting banks' ability to replenish capital during the year. The total nominal tax rate on banks' income will increase to 50% between July and December 2021, considering income tax and CSLL, from 45% currently.

A higher tax burden will likely be passed through to lending rates and business' prices, which would diminish credit demand and volumes. The shape of the recovery for 2021 is moderating from initial estimates because the government lacks the fiscal capacity to provide further assistance packages and because of a slow roll-out of the coronavirus vaccination in Brazil. Therefore, banks' risk appetite is likely to moderate as well. This dynamic will challenge future earnings generation, despite a potential increase in banking spreads.

In 2020, total credit in Brazil grew 16% from a year earlier, backed by government-sponsored loans to small and midsize enterprises (SMEs) and loans to customers affected by the pandemic, two factors that may not be present in 2021. According to Banco do Brasil S.A. (Ba2/(P)Ba2 stable, ba21), Itau Unibanco S.A. (Ba2/(P)Ba2 stable, ba2) and Banco Bradesco S.A. (Ba2/(P)Ba2 stable, ba2) loan guidance for this year, credit will increase 8%-12%. The banks, which together accounted for almost 50% of the system loans as of December 2020, expect credit growth to be boosted by secured loan classes, particularly auto finance, payroll deductible loans, residential mortgages and collateralized loans to SMEs.

Banks' earnings declined an average of 23.2% in 2020 versus 2019,2 largely because of higher provisions for credit losses and lower business volumes. In 2021, earnings will likely be supported by lower provisions and cost savings, although the pandemic continues to challenge the economic recovery and business activities in first-quarter 2021.

The banks' high reserve coverage will mitigate deterioration in asset quality this year as loan deferrals end. However, profitability drivers depend on lending activity and a continued rebound in business volumes to offset the country's low interest rates and strong competition. The CSLL contribution was introduced in 1988 at 9%, calculated on the pretax profit of legal entities. The rate for financial institutions rose to 15% in 2008 during the global economic crisis, with the 9% rate for all other legal entities remaining unchanged. Between September 2015 and December 2018, a 20% rate was applied to private insurers, banks, and financial services firms, while for credit cooperatives the rate rose to 17%. In November 2019, as part of the approval of the Pension Reform, the CSLL rate for banks increased to 20% beginning 1 March 2020, from 15%.