Tight rules helped mitigate crisis in Brazil

If Bernard Madoff had tried to run his Ponzi scheme in Brazil, it would never have got off the ground.

“There could never be a Brazilian Madoff,” says Paulo Oliveira, director for new business at BM&F Bovespa, the multi-asset exchange formed last year by the merger of the São Paulo derivatives and stock exchanges. “The regulators always want to know both sides of all trades.”

In many countries, regulators and exchanges require banks and brokers to reveal only the net position of their clients. If a client is long in one asset and short in another, his net position may be neutral. But he could still be a risk.

But in Brazil, brokers are obliged to provide information on every trade by every client, identified by their registered account number. Mr Madoff, who allegedly invented clients’ trades and had no obligation to deliver proof, would have been stumped.

This is one of many aspects of regulation in Brazil that have helped it avoid the worst of the global economic crisis. Not all beneficial aspects of its regulation have arisen by design. Some are the result of slowness to modernise in the years before the crisis. But many are now being looked at for the lessons they offer.

Alexandre Tombini, director for regulation at the central bank, is among those representing Brazil at meetings of the Financial Stability Forum and the Bank for International Settlements in Basel to discuss regulation and supervision. Brazil’s enhanced presence at both forums follows its work on financial market regulation in the ambit of the G20 group of the world’s biggest industrialised and developing economies.

Mr Tombini points out that Brazil endured several periods of severe volatility in recent decades, although it has become more stable since runaway inflation was conquered in the 1990s. “We are used to dealing with challenging environments, for our institutions and our regulations,” he says. “Everything we have done since the mid- 1990s has tended to take a more cautious approach.”

For example, many countries’ banks are obliged to maintain capital ratios – capital as a percentage of assets – of at least 8 per cent, the minimum recommended by the BIS. Unfortunately, says Ross Levine, an economist at Brown University, “almost all countries have taken the Basel minimums as the norm. They’ve been a lot less cautious than they might have been.”

In Brazil, the minimum required is 11 per cent but many banks keep levels of 16 per cent or more.

Perhaps more question-able are Brazil’s very high reserve requirements – the share of their deposits that banks must park at the central bank. Many countries have phased these out but in Brazil they are about 30 per cent of all deposits.

Francisco Vazquez, a specialist in banking regulation at the International Monetary Fund, says Brazil’s reserve requirements should be replaced with more modern instruments, such as deposit guarantee funds. “The system is so complex that it’s hard to get a good idea of what the cost to banks really is,” he says. It is also one reason why borrowing costs are so high in Brazil.

Nevertheless, when the financial crisis hit last year, Brazil’s central bank was able to release R$100bn ($51.4bn, €37bn, £31.3bn) overnight to ensure banks had sufficient funding.

Similarly, Brazil’s high interest rates are a legacy of past instability that has come in handy in the crisis, giving the bank leeway.

In addition, short selling – selling shares you do not own, often by hiring them – is allowed but naked short selling – selling shares you do not have – is prevented by prohibitive fines for traders who fail to deliver shares they have sold within three days.