Minsky, Financial Governance, Banking,
and Financial Instability in Brazil
FELIPE REZENDE, PH.D .
, NY, USA
,
Research Scholar
Remarks Prepared For The Conference:
“Financial Governance After The Crisis”
cosponsored By The Levy Economics Institute Of
Bard College And MINDS – Multidisciplinary
Institute For Development And Strategies, With
Support From The Ford Foundation
Everest Rio Hotel
Rio De Janeiro, Brazil
September 26–27, 2013
MINDS
The conference in Rio de Janeiro also represents the
beginning of a multi-year grant awarded by the Ford
Foundation to MINDS to conduct research on two
intertwined projects
—  Financial Governance, Banking, and Financial
Instability in Brazil: Analysis and Policy
Recommendations
—  Financing Innovation and Development: The
Role of Public Banks and Non-Banking Public
Institutions. The Cases of Brazil, India and
China.
—  http://www.minds.org.br/
Outline
—  Regulatory and supervisory framework failure in AEs
—  Minsky’s alternative approach
¡  Instability Theory
¡  Banking and Financial Regulation
¡  Evolution of financial systems
—  New Development strategy
Where Do We Stand?
Brazil: A Bubble Economy
—  Kregel (2009) characterized the evolution of
developing countries in the New Millennium as a
“bubble”, for if the US economy was experiencing a
financial bubble the counterpart of that bubble was
the extremely beneficial conditions in developing
countries and in particular in Latin American
emerging markets…we cannot foresee a return to
the extremely positive conditions experience by
developing countries in the recent past.”
—  virtually all of the positive performance that led
to achieving the Brazilian dream of meeting the
target of the BRICs appear to be linked to a
financial model and financial flows that is not
likely to be reestablished. The degree of leverage
that had become normal in developed country financial
institutions will not return, the leverage generated by
financial derivatives will now be couched in much
stronger margin requirements. This will not only mean
lower asset prices but lower global demand for
emerging market exports and thus reduced financial
flows to emerging markets including the BRICs…there is
general similarity across all BRIC economies for they all
depend on expanding demand through increasing
global trade and global imbalance financed by global
financial flows.
Unsustainable global demand and
financing patterns
—  Prior to the Great Recession, exports from
developing and transition economies grew rapidly
owing to buoyant consumer demand in the
developed countries, mainly the United States. This
seemed to justify the adoption of an export-oriented growth
model. But the expansion of the world economy,
though favourable for many developing countries,
was built on unsustainable global demand and
financing patterns. Thus, reverting to pre-crisis
growth strategies cannot be an option. Rather, in
order to adjust to what now appears to be a structural shift
in the world economy, many developing and transition
economies are obliged to review their development strategies
that have been overly dependent on exports for growth.
UNCTAD, Trade and Development Report, 2013, p.1-2
A New Global Structure
Global trade growth grounding to
a halt
Demand supported by
credit growth in EMEs
Current account balance as a percentage of
world gross product
Yield Curves of Selected Emerging Market
Economies
Minsky Instability Theory
Periods of growth and tranquility validates expectations and
existing financial structures, which change the dynamics of
human behavior leading to endogenous instability, increasing
risk appetite, mispricing of risky positions, and the erosion of
margins of safety and liquid positions
—  Kregel-Minsky model
¡ 
¡ 
¡ 
Provision of liquidity
Macro condition
Micro condition
Lifted the external constraint
Policy Rate Selic
Bank Credit % of GDP
Bank claims on the private sector , selected countries, 1990–
2012(Per cent of GDP)
Macroeconomic and microeconomic aspects to
financial fragility
—  Core of Minsky’s financial instability: Assets
purchased through the issuance of debt.
—  Kregel 2009:
—  At the macro level: government deficits create cash.
—  At the micro level: sources of cash flows and cash
flow sensitivity, reliance on position making
operations to raise cash.
—  Banks, Business firms, and households are short
cash.
—  “Cash to cover short position”
Public Sector Net Debt
Public Debt Interest Payments
Principles of macro accounting
—  one sector’s surplus equals the other sector’s deficit.
—  Domestic Private Balance + Domestic
Government Balance + Foreign Balance = 0
Domestic Private Balance = government deficit
+ Current Account Balance
Brazil: Financial Balances
Currency issuer and Currency users
Valor a preços correntes (1 000 000 R$)
200 000
150 000
100 000
50 000
0
2000
2001
2002
2003
2004
2005
2006
2007
2008
(-) 50 000
(-) 100 000
(-) 150 000
(-) 200 000
Non-government financial balance
Government sector balance
2009
Financial Balances (sign reversed for GSB and
ESB)
Valor a preços correntes (1 000 000 R$)
200000
150000
100000
50000
0
2000
2001
2002
2003
2004
2005
2006
2007
2008
-50000
-100000
Government sector balance sign reversed
External sector balance
Domestic nongovernment sector balance
2009
Financial Balances % of GDP (sign reversed for
GSB and ESB)
8%
6%
4%
2%
0%
2000
2001
2002
2003
2004
2005
2006
2007
2008
-2%
-4%
-6%
Government sector balance sign reversed
External sector balance
Domestic nongovernment sector balance
2009
-4
Government balance
External Balance
Private sector balance
Apr-13
Nov-12
Jun-12
Jan-12
Aug-11
Mar-11
Oct-10
May-10
Dec-09
Jul-09
Feb-09
Sep-08
Apr-08
Nov-07
Jun-07
Jan-07
Aug-06
Mar-06
Oct-05
May-05
Dec-04
Jul-04
Feb-04
Sep-03
Apr-03
Nov-02
% GDP
Sectorial Financial Balances
Financial Balances % GDP 12-month rolling sum
8
6
4
2
0
-2
Brazilian Sectorial Financial Balances
Financial balances as % of GDP
Nonfinancial corporations
Financial institutions
Public Sector
Households
Rest of the World
2000
-1%
1%
-5%
1%
4%
2001
-2%
3%
-7%
1%
5%
2002
-1%
4%
-6%
1%
1%
2003
2%
2%
-5%
1%
0%
2004
2%
2%
-3%
1%
-1%
2005
1%
3%
-3%
0%
-1%
2006
1%
4%
-5%
0%
-1%
2007
-1%
5%
-5%
0%
0%
2008
-2%
3%
-3%
0%
2%
average average
2009 2000-07 2008-09
0% 0.04% -1.11%
3% 3.06% 2.80%
-5% -4.76% -3.73%
0% 0.84% 0.18%
2% 0.82% 1.86%
Decomposition of Credit and household
indebtedness
Household Debt outstanding and debt service
ratio
50
45
40
35
19881 - Household debt service
ratio - Seasonally adjusted data
-%
30
19882 - Household debt - %
25
20399 - Household debt service
ratio without mortgage loans Seasonally adjusted data - %
20
15
20400 - Household debt
without mortgage loans - %
10
Jan-13
Jul-12
Jan-12
Jul-11
Jan-11
Jul-10
Jan-10
Jul-09
Jan-09
Jul-08
Jan-08
Jul-07
Jan-07
Jul-06
Jan-06
Jul-05
0
Jan-05
5
Household Debt Service Ratio
25
20
15
10
19879 - Household debt service ratio - Principal - Seasonally adjusted data - %
19880 - Household debt service ratio - Interest - Seasonally adjusted data - %
19881 - Household debt service ratio - Seasonally adjusted data - %
Apr-13
Jan-13
Oct-12
Jul-12
Apr-12
Jan-12
Oct-11
Jul-11
Apr-11
Jan-11
Oct-10
Jul-10
Apr-10
Jan-10
Oct-09
Jul-09
Apr-09
Jan-09
Oct-08
Jul-08
Apr-08
Jan-08
Oct-07
Jul-07
Apr-07
Jan-07
Oct-06
Jul-06
Apr-06
Jan-06
Oct-05
Jul-05
Apr-05
0
Jan-05
5
Household debt service ratio – Principal and
Interest (Jan 2005 = 100)
250
200
150
100
Household debt service ratio - Principal (Jan 2005 = 100)
Household debt service ratio - Interest (Jan 2005 = 100)
May-13
Jan-13
Sep-12
May-12
Jan-12
Sep-11
May-11
Jan-11
Sep-10
May-10
Jan-10
Sep-09
May-09
Jan-09
Sep-08
May-08
Jan-08
Sep-07
May-07
Jan-07
Sep-06
May-06
Jan-06
Sep-05
May-05
0
Jan-05
50
Composition of households bank debt
Minsky, Financial Governance, Banking,
and Financial Instability in Brazil
FELIPE REZENDE, PH.D .
, NY, USA
,
Research Scholar
Remarks Prepared For The Conference:
“Financial Governance After The Crisis”
cosponsored By The Levy Economics Institute Of
Bard College And MINDS – Multidisciplinary
Institute For Development And Strategies, With
Support From The Ford Foundation
Everest Rio Hotel
Rio De Janeiro, Brazil
September 26–27, 2013
MINDS
The conference in Rio de Janeiro also represents the
beginning of a multi-year grant awarded by the Ford
Foundation to MINDS to conduct research on two
intertwined projects
—  Financial Governance, Banking, and Financial
Instability in Brazil: Analysis and Policy
Recommendations
—  Financing Innovation and Development: The
Role of Public Banks and Non-Banking Public
Institutions. The Cases of Brazil, India and
China.
—  http://www.minds.org.br/
Outline
—  Regulatory and supervisory framework failure in AEs
—  Minsky’s alternative approach
¡  Instability Theory
¡  Banking and Financial Regulation
¡  Evolution of financial systems
—  New Development strategy
Minsky’s view of banking
—  Buy assets by issuing liabilities.
—  Endogenous money creation
—  Growth of private endogenous liquidity during
booms.
—  Minsky: “Banking is not money lending; to lend, a
money lender must have money. The fundamental
banking activity is accepting, that is, guaranteeing
that some party is creditworthy.” (1986)
Banks treasury security holdings and the Selic
Rate
36%
22.0
33%
20.0
30%
18.0
27%
16.0
24%
14.0
21%
12.0
18%
10.0
15%
Average interest rate on Net Domestic Public Debt (LHS)
Treasury Securities holdings as a share of Deposit money banks assets (RHS)
Mar-12
Nov-11
Jul-11
Mar-11
Nov-10
Jul-10
Mar-10
Nov-09
Jul-09
Mar-09
Nov-08
Jul-08
Mar-08
Nov-07
Jul-07
Mar-07
Nov-06
Jul-06
Mar-06
Nov-05
Jul-05
Mar-05
Nov-04
Jul-04
Mar-04
Nov-03
Jul-03
Mar-03
Nov-02
%
24.0
0%
Treasury securities
Reserves
Foreign Assets
Claim on the private sector (RHS)
May-12
Jan-12
Sep-11
May-11
Jan-11
Sep-10
May-10
Jan-10
Sep-09
May-09
Jan-09
Sep-08
May-08
Jan-08
Sep-07
May-07
Jan-07
Sep-06
May-06
Jan-06
Sep-05
May-05
Jan-05
Sep-04
May-04
Jan-04
Sep-03
May-03
Jan-03
Sep-02
May-02
Jan-02
Changes in Deposit
the money
banks
asset composition
banks asset composition
40%
65%
35%
60%
30%
25%
55%
20%
15%
50%
10%
45%
5%
40%
Balance of Credit Operations by capital
origin of banking institutions US$ million
Housing Finance System (SFH)
—  Under this system, the minimum lending requirement to
housing loans is equal to 65% of savings deposits held at
banks.
—  Outstanding mortgage debt has almost twentyfold since
2002. However, it was widely believed that the growth of
savings deposits would be below mortgage lending
demand growth. The conventional argument of the
advocates of the development of the securitization
market is that savings deposits will be insufficient to
meet the growing demand for mortgage loans in Brazil,
the argument is that mortgage lending loans outstanding
will exceed 65% of savings deposits
Liquidity Creation
—  The creation of new sources of financing and funding
are at the center of discussions to promote real
capital development in the Brazil. It has been
suggested that access to capital markets and longterm investors are a possible solution to the dilemma
faced by Brazil’s increasing financing requirements.
—  The Brazilian response to the funding shortfall
included policy initiatives to revive Brazil’s capital
market funding.
Breaking banks’ monopoly on Liquidity creation
—  Regulatory reforms implemented in the late 1990s and during the
2000s have laid the foundation for the development of the
securitization market and allowed the creation of new alternatives of
liquidity creation.
—  The development of the Sistema Financeiro Imobiliario (SFI),
established in 1997, would presumably provide the funding
necessary for the expansion of the housing market and the
corresponding reduction of the housing gap in Brazil.
—  The strategy adopted with recent regulatory reforms emphasized
loan origination growth by lending institutions and the sale of asset
pools to securitization structures (such as receivable investment
funds and securitization companies) thus reducing banks’ on
balance sheet asset liability mismatches and capital requirements.
—  This policy initiative has been driven by the belief that access to
capital markets would provide the funding necessary for the
expansion of the housing market and the corresponding reduction
of the housing gap in Brazil
Breaking banks’ monopoly on Liquidity creation
—  The number of structured finance deals and securitization
structures sharply increased in the past decade as a series of
reforms were introduced to foster the growth of the
securitization market in the country.
—  Despite the original intent of regulatory reforms in the context
of SFI to develop the mortgage lending market, asset-backed
securities (ABS) backed by personal loans, auto loans,
receivables future flows took off and are common ABS
transactions.
—  Since the creation of Receivable investment funds in 2001, or
Fundos de Investimento em Direitos Creditórios (FIDCs), the
range of underlying assets backing securitization deals has
broadened including (but not limited to) consumer loans, auto
loans, future flow receivables, and non-performing loan
portfolios) and originators typical include banks, finance
companies, companies (small, medium, and large), and
governments.
Lack of Savings and financing mechanisms or shortterm portfolio preferences?
—  IMF 2012: “Brazil is still stuck in a high interest rate-
low duration equilibrium”
Loan Portfolio Yield and funding costs
35.00
30.00
25.00
20.00
%
Loan Portfolio Yield
Funding cost
15.00
Average spread
Average Policy Rate- Selic
10.00
-
Jun-02
Feb-03
Oct-03
Jun-04
Feb-05
Oct-05
Jun-06
Feb-07
Oct-07
Jun-08
Feb-09
Oct-09
Jun-10
Feb-11
Oct-11
5.00
Expenses for ALL as a share of banks’ credit
portfolio
Brazilian Bank’s return on equity
Capital and Leverage Ratio
Financing Long Term Assets
—  Roberto Setubal, chief executive of Itaú Unibanco, points out
that
—  [Mortgage funding] will need to be developed in Brazil, but
in a different way. We will not be financing long-term assets
with short-term deposits in the way it was done elsewhere in
the world…Since we are facing this liquidity perspective, and
let’s assume mortgages will grow at 40% a year because
today they are less than 5% of the total portfolio, and let’s
also take account of Basel III liquidity requirements, [then]
it’s obvious we cannot use savings or demand deposits to
close this gap. That’s why there is a big discussion in Brazil
about what would be the right funding for mortgages…Given
the high level of interest rates this is a problem and this is
why Brazil has never developed this before. A lot of current
proposals, such as covered bonds, will help but if we don’t
have single-digit interest rates it will not happen” (
Caplen 2011)
Banks’ Maturity Mismatch
Liability Structure of Brazilian Banks
How to characterize financial systems?
—  The important question is related to the costs of
carrying a mismatch between the duration of assets
and liabilities on the bank balance sheet, that is, if
interest and funding risks are carried on banks’
balance sheets.
—  Following Kregel (1993), rather than characterizing
financial systems as market based or bank based,
one should distinguish between the risks that are
carried on the balance sheets of banks and other
financial institutions
Banks capital and liquidity ratios
Portfolio preferences
Interest Risk Exposure
—  During the second quarter of 2013 the top three private
banks –Itau Unibanco, Bradesco, and Santanderexperienced massive losses, about R$ 11,7 billion, due to
a negative adjustment to the market value in their
portfolio of securities classified as available for sale
caused by changes in the yield curve.
—  It is, thus, a high and volatile interest rate environment,
due to active manipulations of the central bank’s policy
rate, known as Selic rate, that has shifted portfolio
preferences towards low duration, short-term assets
Mutual Funds
Repo markets and liquidity creation
—  Thank you
Investment as % of GDP
More aggressive increase in treasury investment
as % of GDP
A New Perspective on the role of the Public sector
to Support a National Development Agenda
—  It is not a new insight that growth strategies that rely primarily on
exports must sooner or later reach their limits when many countries
pursue them simultaneously: competition among economies based on low
unit labour costs and taxes leads to a race to the bottom, with few
development gains but potentially disastrous social consequences. At the
present juncture, where growth of demand from developed countries is
expected to remain weak for a protracted period of time, the limitations of
such a growth strategy are becoming even more obvious. Therefore, a
rebalancing of the drivers of growth, with greater weight given
to domestic demand, is indispensable. This will be a formidable
challenge for all developing countries, though more difficult for some than
for others. In any case, it will require a new perspective on the role
of wages and the public sector in the development process.
Distinct from export-led growth, development strategies that give a
greater role than in the past to domestic demand for growth can be
pursued by all countries simultaneously without beggar-thy-neighbour
effects, and without counterproductive wage and tax competition.
Moreover, if many trade partners in the developing world manage to
expand their domestic demand simultaneously, they can spur South-South
trade. UNCTAD, Trade and Development Report, 2013, p.3
Elements of a National Development Agenda
—  No need to rely on external savings, shift to domestic demand led growth
, support domestic income growth and domestic consumption via fiscal policy,
Increase government supported infrastructure investment projects,
enhancing automatic stabilizers, job guarantee program.
fostering the purchasing power of the population in general, and of wage
earners in particular, should be the main ingredient of a domestic-demanddriven growth strategy. While export-led strategies focus on the cost aspect
of wages, a domestic-demand-oriented strategy would focus primarily on
the income aspect of wages, as it is based on household spending as the
largest component of effective demand. if wage growth follows the path of
productivity growth, it will create a sufficient amount of domestic demand
to fully employ the growing productive capacities of the economy… targeted
social transfers and public sector employment schemes can play an
important complementary role.
(UNCTAD, Trade and Development Report, 2013, p. VII-IX)