Brazil monetary and credit cycle review
Interest rates, money supply, credit growth, NPLs, and credit exposures by bank
Over the past year and a half, I’ve been writing a lot about Brazil and its companies. In particular, its banks, capital markets, and payments companies. I hold positions in several of those companies (VINP, XP, BOLSY, PAGS, BSBR).
For that reason, the monetary and credit cycle in Brazil has been taking up a lot of space in my mind. And why preoccupy when one can occupy?
This article covers my analysis of the main risks and trends affecting Brazil’s financial companies, both from a systemic perspective and at the level of specific investment theses. Earlier this year, I wrote an update on the main macroeconomic factors affecting the country, touching briefly on monetary dynamics. Here, I go deeper.
The article covers two sets of risks: depreciation-related and credit-cycle related.
Depreciation matters because balance sheets and earnings across Brazil’s financial companies are fully denominated in BRL. Any currency weakness flows straight through to valuations. Further, generally (not always) a depreciation implies that equities in general perform worse, at least temporarily. In this section, I cover aspects related to the balance of payments, sentiment and external factors, credit expansion in relation to the overall economy, and the risks of a carry trade unwind.
The credit cycle is specifically relevant for banks, and indirectly for consumer discretionary names. The critical question here is how higher rates weigh on credit growth, delinquencies, and employment. I also analyze the exposures of different banks to a worsening credit cycle.
Without further ado, vamos lá!
Other articles on Brazil financials
The context
Although the article below analyzes factors that affect Brazil over the long-term, and are even applicable to other EM markets, the time for the analysis is relevant. We are currently in a context of significant uncertainty regarding Brazil, at least in monetary terms.
Internally, the country is undergoing a credit tightening cycle from September 2024. It is the second tightening cycle since the pandemic, and it is the first under the Central Bank president proposed by the Lula administration (Gabriel Galípolo). In the second half of 2024, the BRL started to depreciate, inflation expectations increased above the Central Bank’s targets, and there were general fears around fiscal sustainability in the country. In that context, the Central Bank raised rates from 10.5% in September 2024 to 15% by July 2025.
The effects of this tightening in the economy are expected to be a deceleration in credit expansion (not necessarily a shrinking in credit) and, eventually, the reduction of inflationary pressure, especially coming from historically low unemployment. In my previous article on macroeconomic factors, I questioned the capacity of Brazil’s Central Bank to manage the cycle (I believe fiscal policy is much more relevant), but nonetheless this is where we are today.
Potentially unintended consequences of the cycle are an overvaluation of the BRL, causing damage to the balance of payments, and the breeding of a credit-induced recession in the country.
Externally, emerging markets have outperformed this year, with the USD weakening against other currencies (including the BRL). However, this trend might reverse, leading to capital returning to the US, with negative effects on emerging markets, Brazil being one of them. Although analyzing this trend is beyond the scope of this article, it is important to have in mind when considering positions in Brazil.
Exchange rate risk
The main monetary risk around any position in Brazilian assets is exchange rate risk. Unless the business derives most of its revenues from exports, its value is directly tied to the value of the BRL.
This is particularly true for banks and financial companies, which have most if not all of their assets denominated in BRL, and that generate all of their profits in BRL. A currency depreciation directly reduces the value of the book and of earnings. In so far as depreciation exceeds inflation (and the country gets cheaper in real terms), then depreciation also affects other domestic-focused companies.
Of course, trying to predict the trend in currencies is beyond my capabilities, but the idea in this section is to go over the many factors affecting this dynamic.
Sentiment factor: international and domestic
We start with the most uncertain, harder to measure and predict factor, which is sentiment (market mood, or spirits). Unfortunately, it is probable that, at least in the short to medium term, this is the most important driver of currency appreciation and depreciation, so we need to at least have it in mind.
Internationally, the sentiment driver is the appetite for ex-USD assets. So far this year, the dollar has depreciated, as reflected in a lower Dollar Index (DXY), and ex-US markets have outperformed, including, importantly, emerging markets, with the EEM ETF as a proxy. However, a reversal, with the dollar strengthening or US assets overperforming, would probably impact Brazilian equities negatively, independently of internal factors. What could drive this reversal? A risk-off, flight to a quality environment, where low-risk assets perform (mainly US debt), whereas risk spreads widen (especially for emerging markets). Of course, a reversal in this is incredibly hard to predict.
Domestically, I believe sentiment gyrates around politics, especially the chances of Lula’s party to reelection in 2026. Whenever polls come out showing that Lula or his potential candidate (the Minister of Economy Haddad) is doing badly in approval, Brazilian assets rise. The election trade started in other countries (Argentina, Colombia, Chile, as recent examples), long before the election. This could be behind the current bullishness in Brazilian assets. This trend could reverse if Lula and his party won or were expected to win. Personally, I would become a buyer if Brazilian assets dropped on a victory (or the potential victory) of the PT, because I don’t share the dichotomic ‘communist Lula’ vs ‘pro-market Freitas’ view. In the past, Brazilian assets performed wonderfully under Lula and terribly under ‘pro-market’ governments.
Fundamentals: payment mediums, BoP, and carry trade
Sentiment is hard to predict, but when it goes parabolic (either depressive or manic) and separates too much from fundamentals, it might offer opportunities.
When discussing fundamentals, we are focusing on those factors of the Brazilian economy or monetary system that take longer to steer and generate effects, but that nonetheless end up determining whether the currency and local assets trade at sustainable levels or not.
Specifically, I think three questions are important in this respect: are payment mediums growing faster than the real economy and inflation; is the balance of payments dynamic sustainable; and is there a carry trade forming?
Payment mediums are growing well above GDP but decelerating
We can observe below that money measures have been consistently growing above nominal GDP (which already incorporates inflation), and potentially as much as 10 percentage points above real growth in the post-pandemic period of 2/3%.
The growth in payment mediums above real GDP is a source of instability because when credit and money in broad terms grow faster than production, they increase inflation and worsen the balance of payments. When there’s more money chasing the same internal goods, those goods rise in price (inflation), and exports become less competitive. At the same time, a part of that excess demand will be satisfied by imports, also lowering the trade balance. In an open capital account system like Brazil, most money can be converted into foreign currency, also leading to FX pressure.
When considering money, we should use broad money measures, which include credit, money market funds, and short-term federal debt. The reason is that credit quickly becomes currency with buying power, and that most short-term financial assets can be converted to cash at low cost, unless the country wants to see its short-term rates skyrocket (like in my beloved Argentina recently). One man’s debts are another man’s assets, and nowhere is this truer than in our current fractional reserve bank system.
Further, one could argue that the main role of a hawkish Central Bank is to slow down the speed of credit creation. This is what makes inflation pressure recede. If rates are high and credit continues to grow, then the CB is just throwing fuel into the fire. In this last respect, we can observe a deceleration in broad money supply growth coincident with the Central Bank raising rates in September 2024. Money supply is now growing at 7/8% YoY in nominal terms, which is already in line with nominal BRL-denominated GDP. In particular, as we will see below, many forms of credit have started to contract or significantly decelerate YTD.
Deteriorating balance of payments, but not unsustainable
In the Brazilian macro article from May 2025, I had already covered a deterioration of the balance of payments, which has continued into 1H25. Indeed, since its lowest level in February 2024 (-1.5% of GDP), the current account deficit has worsened to -3.5% of GDP in July 2025.
The main driver of this dynamics has been an increase in import quantities, explaining 75% of the decrease in the trade surplus. When we take a look at export/import dynamics, we can observe that export quantities are still growing (albeit 50% slower than imports), but they fall in prices because most Brazilian exports are commodities.
Although the trend is not positive, so far the dynamic seems sustainable. Several factors explain this.
First, we can talk of a commodities downcycle, particularly in cereals, oil and minerals (Brazil’s core exports). This implies the country’s exports are in a negative period, which could revert positively. The commodities cycle is fairly tied to the USD cycle, so a depreciating USD helps commodities. Still, the risk is that commodities move even lower from here.
Second, the goods surplus is still fairly positive, as much as 3% of GDP ($60/70 billion). When adding the services deficit of $50 billion, the trade balance stands at breakeven.
What makes the current account deficitary is high rent payments (capital earnings), also at about 3% of GDP. However, the majority of those earnings are equity earnings reinvested in the country and become positive FDI.
Finally, the country has significant reserves, at about $330/350 billion. This should be sufficient to cover a small trade deficit or lower FDI for some years.
No foreign carry trade, but risk of residential flight to the dollar
The last point is the risk of a large carry trade building up, leading to instability when it unwinds.
Given that the interest rate differential with the US is currently 10/11 pp, and that the exchange rate has appreciated 20%, a carry trade position in BRL has been very profitable. The risk is that this attracts foreign funds that then grow in BRL inside the country, only to flee at the worst possible time.
The data does not show growth above the rest of the financial system in foreign-owned credit assets. Of course, the aggregate figures (~R$900 billion or $150 billion) are significant, but still only 50% of reserves.
In comparative terms, there’s a much higher risk stemming from residents. We should remember that Brazil has an open capital account, including residents. So far, Brazilians have preferred to remain invested in BRL assets, including, of course, debt, which yields way above inflation. However, if this changed, there’s a lot of dry powder to drop the BRL and buy foreign-linked assets (USD itself, or linked, like BDRs).
Exchange rate risk conclusions
Adding up all of the above, my conclusion is that the fundamentals do not point towards a clear imbalance, but there’s space for a sentiment change to scale up. That is, the risk of a depreciation in the next year and a half is moderate to high.
Furthermore, there’s reflexivity in these dynamics, with sentiments worsening fundamentals and vice versa. A stronger USD generally means lower commodities and lower FDI, both pressuring the balance of payments. In a context of depreciation, residents also try to move out of BRL assets, adding to the problem.
Therefore, although Brazil is not brewing an FX time clock, the risk is there. I don’t think a moderately cheaper FX (say in the R$6.5 region, 20/25% cheaper), is necessarily negative for the country, but this can be damaging to equity prices in the short-term at least. In the past, the Central Bank has allowed the currency to move freely, with only moderate intervention to reduce volatility, but not to arrest the trend.
Business/credit cycle risk
The second type of risk is the general cooldown of the economy because of higher rates.
In general terms, and just like any cycle, discretionary industries are more exposed than defensive industries. Inside financials, banks are more exposed than brokers or payment processors. Finally, inside banks, subprime lenders to consumer lines (ex, Nu) are more exposed than regulated credit lenders (ex, Caixa).
Specifically, the perplexing concept of a ‘growth-bank’ (Nu, Inter mainly), becomes a liability when the cycle starts to deteriorate, because management has to keep the street happy (growth), but this can only be done by adding risk at the worst time possible.
Impacts so far
The Central Bank’s direct goal is to return inflation expectations to 3/4%. This can be done only indirectly by reducing credit growth. The Central Bank started raising rates in September 2024, from about 10%, to a ‘wait-and-see’ level of 15% by July 2025.
Because of lags, effects are only starting to be felt now in credit costs, credit growth, and delinquencies, and even more slowly in economic growth and inflation expectations. Inflation has decreased relatively fast YTD, but that has been driven more by an appreciating FX than by fundamentals.
Small impact on the cost of credit
Starting with credit costs, the effect exists, but is way smaller than for the reference rate. The reason behind this is that spreads are high in Brazil, and therefore, in some categories, the reference rate makes up only 1/3 of the cost.
We can see below that the cost of unregulated (livre, interest rate, and allocation relatively uncapped) has gone from 52% to 58% for individuals, and from 21% to 25% for companies. That is, respectively, an increase of 10% and 20% on interest, versus 50% for the reference rate. The effect is similar when we also consider the weight of regulated credit (credito direcionado, capped rates, and mandated allocation) on total indebtedness. The right-hand chart shows that aggregate costs of credit grew 12.5% and 22%, respectively.
Because credit costs are not meaningfully higher, it is unlikely that credit demand is slowing down. The deceleration in credit creation we will see below is probably coming from the banks, not from the borrowers.
Credit is slowing a little for companies, but not for individuals
The impact of higher rates is more evident on slower credit growth, particularly for companies. Most banks are guiding for much slower loan book growth in 2H25, of around 4/7% nominal (i.e., in line with nominal GDP).
We can observe below that since December 2024, credit for companies has stalled on the unregulated lines and slowed down on the regulated lines. Contrary to this, credit to individuals continues unabated, even after removing the effect of due-date credit card growth.
There are several explanations for this divergence.
First, NPLs tend to react faster among companies than among individuals, because companies carry more leverage and have limited liability. This leads to banks increasing their lending standards in preparation for a worsening of the cycle, and decreasing lending to companies first.
Second, local capital markets are playing a larger role in company financing, especially for larger companies. This factor was, admittedly, already a reality before the Central Bank rate increase, but it is still important because securities issued in the capital markets are not considered in the figures above.
Third, individuals as a collective are in their best income position in a long time. Unemployment is at a historical low, and the inflation-adjusted income mass is at historical highs. Formal employment has been growing much faster than informal (therefore providing a demonstrable income to get credit), and the income gains have been stronger among the lower classes. That means individuals currently score very well on credit, and banks have more appetite for that type of credit.
NPLs are picking up on mix
Maybe where the cycle is tightening up faster is in NPLs, which are growing almost in line with the SELIC. However, when we analyze the specifics, we can observe that it is a matter of both mix and fundamentals.
In particular, NPLs are growing faster among individuals, in both directed and free lines. This seems contradictory to the comments about the low unemployment and record real income.
On the directed side, it can be almost fully explained by the increase in rural delinquencies, more related to a vicious downcycle in crops. Almost all rural credit is directed and is recorded as individual credit, not company credit.
On the free side, the driver is mainly lending growth in riskier lines. Growth in the riskiest lines of individual credit (non-payroll, refinanced credit cards, and vehicles) explains 55% of free credit growth to individuals since November 2024, although these lines represent only 35% of all credit. Still, we can observe an increase in NPLs within each line too.
Something similar is happening with companies, where the largest lines, representing as much as 60% of all credit in free modalities, don’t show NPL worsening, indicating a mix-driver.
Analyzing bank exposures
The data above does not show a significant credit deterioration yet, because, as we saw, at least 50% of the increase in NPLs is driven by mix, not in-line NPLs. However, given the slowdown in credit and record low unemployment, it seems logical to expect an increase in NPLs forward.
Given this outlook, I believe a defensive positioning in terms of bank exposure is advisable, either by avoiding banks and focusing on other financials, or by avoiding the banks that work with subprime lending more.
Asset classes
At the first layer of analysis, we need to separate between asset classes and how they generate income for the banks. We know that credit is the highest risk class, with the rest having very low or even negligible risk (except maybe for securities, if they are not government securities, but the risk is still much lower).
We can observe that the large banks have the highest asset exposure to credit, without distinguishing credit quality.
However, the asset composition is only part of the picture. When comparing by income, the smaller digital banks are more exposed to credit risk. This happens because the smaller banks have higher risk-adjusted NIMs.
Credit exposure
Now delving deeper into credit, we need to distinguish risk categories. The chart below stacks the credit book of each bank by approximate risk. The directed and secured loan categories have the lowest risk. This includes mortgages (1% NPLs), foreign trade financing, receivables refactoring, and secured payroll. Currently, rural credit (mostly in the hands of BB) is doing much worse, but it follows its own cycle. The ‘high risk’ credit categories are marked in purple (unsecured payroll loans and credit cards, excluding due-date).
We can easily observe that the public banks concentrate on lower risk, directed credit (categories in grey), with most private banks in medium risk categories (NPLs ~ 5%, categories in blue and dark blue), and Nu and Inter on a category of their own of super high risk lending (categories in purple).
The same can be confirmed by observing BACEN credit ratings for individuals, showing a downward scale from the public banks (best credit) to the digital banks (worst).
Conclusions
The goal of this article is to study two types of risks regarding Brazilian equities.
The first is the risk of a depreciation of the currency. It affects all Brazilian companies, except those that are export-oriented (of which Brazil has plenty). After analyzing this risk, I believe the country is not breeding a foreign currency crisis from the inside. Money supply growth is returning to levels in line with nominal GDP growth, reserves are plenty, foreign debt is low, and the balance of trade remains positive (albeit with a negative trend) despite a vicious downcycle in export commodities. On the other hand, the risk of a global flight out of emerging markets and into quality assets, i.e., a strengthening of the dollar globally, remains. That risk is shared by all emerging markets and even by all commodity markets. In the scenario of a strengthening dollar globally (not a locally depreciating BRL), not even commodity exporters in Brazil would be safe.
The second type of risk affects mostly banks, and in second place, companies exposed to domestic discretionary demand. In this respect, I do believe the cycle can deteriorate further, with NPLs rising and credit tightening further. For this reason, I prefer to avoid low-quality lending banks in favor of either other financials or better-quality banks. I’m also concerned about positions in discretionary sectors, albeit the impact in this sector could be more moderate than on banks if there’s a ‘medium landing’.