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Brazil's sovereign creditworthiness could be affected by the impact of the February ruling by the Supreme Court (photo), S&P warns. (Photo: Everton137)
Wednesday, January 8, 2014

Brazil: Lawsuits Threaten Banks

Ruling by  Brazil’s Supreme Court could have a
profound impact on Brazil's banking system, experts say.

Inter-American Dialogue 

In February, Brazil's Supreme Court plans to rule on lawsuits brought by bank depositors affected by banks' adherence to government policies to fight hyperinflation two decades ago. The suits could cost the banks, which include market leaders Itaú Unibanco and state-held Banco do Brasil, a total of $65 billion-more than a quarter of the banking system's equity. What is at stake in the case for Brazil's banking sector and the country's economy? Which way is the court likely to rule? What precedent could a ruling in this matter set for future cases related to other sectors or industries?


Walter José Faiad de Moura, partner at Moura Lamounier Advogados in Brasília and Marilena Lazzarini, president of the board of directors of the Brazilian Institute for Consumer Defense (IDEC): There is no doubt that the Brazilian government's measures in the 1980s were intended to reduce currency inflation. However, in July 1987 and January 1989, banks applied a lower indexation to savings accounts, on their own and without any statutory command. As a consequence, the amount deposited by individuals was reduced. Banks were not bound by any legal norm to proceed in that way. Brazilians savers sued banks to recover the values they lost. In addition to the individual lawsuits, IDEC has led class actions under Brazilian law to defending collective interests. During 25 years of litigation, courts including the Supreme Court ruled that the central bank and the government had no liability because banks had a private relationship with consumers. The amount owned by the banks is considerable. However, it is far less than $65 billion because banks ignore that many savers have died. Also, many savers had very little deposited and have not sought justice. The Supreme Court could rule in favor of the plaintiffs without creating a major impact on Brazil's economy nor increasing economic risks. Any money awarded to savers would return to the economy.


Fausto Sanchez and Elizabeth Cantu, associate attorneys at Diaz Reus & Targ LLP: In February, the Brazilian Supreme Court is scheduled to rule on the landmark case, the outcome of which could significantly affect the country's economy. Depositors have sued multiple Brazilian banks, both private and government controlled, to recover losses incurred through the implementation of government policies between 1986 and 1994. The Bresser, Verão and Collor plans, adopted under the presidencies of José Sarney and Fernando Collor, were designed to tame hyperinflation. These mandates required banks to take drastic measures, including freezing assets and bank accounts of depositors. The constitutionality of each plan has been attacked, and early indications of a projected outcome seem to be split. Analysts indicate the Supreme Court is likely to uphold lower court rulings regarding the Collor plans, which favored the banks. The suits against the Bresser and Verão plans, however, may result in judgments for the plaintiffs. If the Supreme Court rules in favor of the depositors, it could set a precedent that allows businesses to be held liable for steps they take to adhere to a governmental policy. A ruling in favor of the plaintiffs on all of the plans could cost the banks up to 150 billion reais ($65 billion). Such a judgment could send the Brazilian economy into a tailspin, as banks would likely raise the cost of credit significantly. With so much at stake, many expect the Brazilian Supreme Court to avoid the economic catastrophe and rule in favor of the banks.


David Fleischer, emeritus professor at the University of Brasília and editor of Brazil Focus: The pending Supreme Court ruling regarding lawsuits filed by bank depositors requesting adequate monetary correction on their deposits during the heterodox anti-inflation plans in the 1980s and 1990s could have a profound impact on Brazil's banking system. However, there are important considerations that should be emphasized. The banks have made 'provisions' for these extraordinary expenses out of their very large profits over the past years. Also, because this affects savings accounts, Caixa Econômica Federal (the federal savings bank) would have the largest impact and these losses would be compensated directly from the federal treasury, that is, the taxpayers. The high court has postponed its deliberation of this case until early 2014. What might the court's decision involve? When deciding the constitutionality of the 'Collor Plan' decreed in March 1990, the Supreme Court decided that the confiscation of financial assets was 'constitutional.' Although most of the judges felt that this measure was really unconstitutional, had they rejected this plan ex post facto, this would have caused total chaos in Brazil's economy. It is possible that in 2014 the Supreme Court will rule in favor of bank depositors but that the monetary correction on these deposits should be returned in stages so that the impact would occur over several months or years.


Sergio Garibian, analytical manager for financial services in Latin America at Standard and Poor's: Over the past 20 years, many Brazilian banks have been hit with litigation related to savings accounts. The plaintiffs claim that the indexation rates applied to their deposits during the economic stabilization programs of the late 1980s and early 1990s were deficient. In our opinion, it's too early to estimate the cost and the possible effects on the Brazilian financial system until the Supreme Court rules on the constitutionality of the different indexation adjustments applied to each of these programs. That said, estimates presented in the media and by market participants put the potential costs for banks as high 600 billion Brazilian reais, equivalent to 12.6 percent of the country's GDP. Other estimates that, according to the media, were calculated by government agencies set the total cost at about 150 billion reais, or 3.1 percent of GDP. The final amount could be lower than this, depending on whether the Supreme Court rules some or all of the programs involved as unconstitutional. We believe our 'BBB' foreign currency and 'A-' local currency sovereign credit ratings and negative outlook on Brazil incorporate to some extent the contingent fiscal risks that could affect the sovereign. However, sovereign creditworthiness could be affected directly through the impact of the Supreme Court's ruling on government-owned banks, such as Caixa Econômica Federal or Banco do Brasil, and indirectly through the health of private banks considered systemically important. In addition, sovereign creditworthiness could come under pressure as a result of the effects that more restricted credit growth will have on Brazil's economic prospects. We have frequently highlighted Brazil's restricted fiscal flexibility, which exceeds the government's already high debt level, as a key determinant of our sovereign rating on Brazil.

Republished with permission from the Inter-American Dialogue's daily Latin America Advisor


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