MercoPress. South Atlantic News Agency

Two Brazilian mid-sized banks ordered liquidation by monetary authorities

Cruzeiro do Sul thrived on consumer lending and its failure could mean problems for banks in the mid-size ranking

Brazil's central bank ordered the liquidation of Banco Cruzeiro do Sul on Friday after no one stepped up to acquire the troubled lender, raising doubts about government oversight of small and mid-sized banks.

The central bank also ordered the closure of Banco Prosper, which Cruzeiro do Sul had agreed to take over last November.

The decision follows three months of talks between Cruzeiro do Sul's creditors, investors and rival banks to cut mounting debts and find a buyer for the Sao Paulo-based lender. Cruzeiro do Sul was seized by the central bank in June following fraud allegations.

The episode is unlikely to destabilize Brazil's banking system, although it might dent confidence in the soundness of mid-size lenders and tarnish the central bank's credibility as a sector watchdog, analysts said. Cruzeiro had control of only 0.24% of the nation's banking assets and 0.33% of deposits.

The closure also shines a spotlight on the role of Brazil's deposit guarantee fund and the way bondholders were forced to bear most losses stemming from Cruzeiro do Sul's bankruptcy.

Privately owned deposit guarantee fund FGC, which has run Cruzeiro do Sul since it was seized by the central bank, said it was unable to find a buyer for the lender. Efforts to convince bondholders to accept a debt buyback, in which the value of their holdings would be cut by about half, also failed, FGC said.

Cruzeiro do Sul is the second bank liquidated in Brazil in the last year and half and the biggest since Banco Santos was shuttered in 2005 amid evidence of widespread fraud. Years of fast credit growth resulted in deteriorating funding and liquidity conditions for mid-size lenders and, in some cases, led to the relaxation of accounting controls.

Brazil's central bank sought to play down concerns about systemic risk and pledged to work with judicial authorities to prosecute those responsible for any wrongdoing at Cruzeiro do Sul.

“The central bank will continue to take all necessary measures to assess responsibility within its legal power,” it said in a statement.

A flurry of central bank controls aimed at enhancing oversight in the past year have made it harder for mid-size lenders to comply with regulations, FGC Chairman Antonio Carlos Bueno said in June. Those controls are failing to improve the quality of accounting, according to Ronac and other analysts.

BM&FBovespa, which operates the nation's stock exchange, halted trading in Cruzeiro do Sul shares on Friday before the liquidation was announced.

Shares of the lender, which specialized in payroll-deductible and other consumer loans, had surged more than 40% this week on optimism that FGC and bondholders would agree on the debt-reduction program and Cruzeiro would be bought by a rival.

Cruzeiro do Sul's collapse comes at a time when President Dilma Rousseff is pressing banks to slash borrowing costs. Some analysts say mid-size banks face more trouble as lower interest rates weigh on revenue and prompt some lenders to adopt riskier lending practices.

Assets at mid-size banks have tripled since 2006 at the expense of eroding solvency. As demand for lending remained firm, mid-cap banks embarked on ambitious growth plans that are to blame for their current capital shortfalls, analysts say.

More problems may surface if authorities don't move to address the segment's inefficient funding structure, in which cash flow mismatches are frequent, said Peter Coradi, a former adviser to mid-size banks. Smaller lenders should focus more on niche products and less on personal credit.