Last July, following recommendations from The Bank for International Settlements (BIS), Brazil's Central Bank ordered the country's financial institutions to implement a system allowing online, real-time payments between banks, an enormous undertaking expected to affect a sea change in the Brazilian banking system.

Now, a full year later, Brazil's banks continue rushing toward the Nov. 1 deadline to convert from payment by batch systems to Sistema de Pagamentos Brasileiro (SPB), the new online, real-time system. Faced with such enormous and rapid change, the Central Bank has eased its original deadline to allow banks to continue the traditional batch system practice of executing transactions while running a negative balance until next January. Still, despite help from the Central Bank and the loosened deadlines, there is doubt all banks will be ready by that date.

Meanwhile, Brazil's financial institutions, while assessing how they will be internally affected by SPB, are also preparing for the massive ripple effect the adoption of the online, real-time system is expected to have on the country's banking network. Analysts predict the adoption of SPB could trigger everything from mergers between banks to resentment of the Central Bank's handling of the SPB to foreign investment and an improved image of Brazil's sometimes beleaguered banking system.

Before the recommendation from BIS, an international organization based in Basel, Switzerland, that pursues monetary and financial stability by fostering cooperation among central banks and other agencies, Brazilian banks' batch system had a built-in lag of one day or more in transactions. Under that system, a customer wrote a check, the check went to the clearinghouse, the clearinghouse sent it to the bank and the bank had 24 hours or so to pay. As a result, those banks, which need not worry about having funds available at a moment's notice, could habitually operate with a negative balance. The Central Bank's order to switch to SPB pushes Brazil's paper-happy banks-which tend to pay their bills with checks-into the electronic age.

With SPB a bank must have the funds available whenever a customer makes a payment. That requires banks to become shrewder in cash flow management. For the first time, with SPB, all Brazilian banks, clearinghouses and the Central Bank will be integrated electronically.

Also, SPB ends the traditional practice of the Central Bank bailing out overdrawn local banks by extending credit. With the new system, private banks will be unable to execute transactions if they lack adequate funds.

Brazilian banks are racing the clock and many banks began testing the SPB system June 1, a move that fueled optimism for eventual mass compliance. However, for some banks, chiefly the smaller ones, reaching the deadline may be a challenge that involves an almost overwhelming investment of time, manpower and money.

Harvesting resources

An example of the far-flung impact of SPB adoption is Sao Paulo- based JPMorgan Brazil. The bank, which began working in February with a vendor, Software Design, to design its SPB system, also entered negotiations with a consultant. Meanwhile, dozens of bank employees were designated to assess SPB's impact, to prepare the bank's infrastructure for compliance and to conjure up new products the system will allow them to launch.

The bank has to put the infrastructure in place: all the servers, the firewall, the links, the MQ (from IBM), and the contingency, says Lisias Lauretti, technology director for JPMorgan Brazil. And also all the security stuff: who can do what when, who makes approvals, who doesn't make approvals.

By June the bank was considering hiring a second consulting company to assess the impact SPB would have on the bank's operations.

So far, JPMorgan has budgeted $1.1 million to adapt to SPB and has three employees dedicated full time to the project, as well as 10 groups of employees working part time, some largely designing products based on the new technology. In all, more than 70 bank staffers are involved.

Like other Brazilian financial institutions with the resources, JPMorgan is also looking for support from its peers. Specialists from JPMorgan and several other Brazilian international banks, such as Deutsche Bank, Merrill Lynch, ING Barings and Lloyds, meet weekly to exchange information relating to the conversion to SPB.

Josino Garcia, chief executive officer for Technology for Banking (T4B), a SPB consulting and technology firm, places JPMorgan's budgeted expenditure below the average of what most banks will spend converting to SPB. He estimates the expenditures by small Brazilian banks will range from $500,000 to $1 million, and that larger banks will spend $4 to $6 million.

JPMorgan's conversion is not as difficult as some, Lauretti says.

We have homework to do, but it is not mission impossible, he says. For some mainframe, commercial banks this might be a nightmare, (but it isn't for us) because we don't have current accounts or branches; we are pretty much an investment bank.

SPB's culture change

SPB is expected to improve Brazil's banking system in several ways, including enabling banks to create new products. For example, when today's bank customer wants to transfer money, the service is available through a product named DOC, which stands for document. With the introduction of SPB, the customer can also transfer money through STR, a transfer system that immediately passes money from one bank to another. Or money can be transferred via CIP (Camara Interbancaria de Pagamentos), a clearinghouse for check compensation.

The new SPB system will elevate Brazil's banking system to the same level as those in the United States, Mexico and several European countries that already use online, real-time payment systems.

Everyone teases you saying that Brazil is always different, and so I say Brazil is becoming normal, says Lauretti.

But, in effect, Brazil's global normalization advances it beyond its neighbors, making it abnormal in its region. The SPB is very good for us because, when we change the payment systems and the accounts we will be in a situation where investors can come to the country and risk, in terms of transactions, will be smaller than for the other countries in Latin America, T4B's Garcia says, noting that SPB vendors, such as Brazil's EverSystems, hope Brazil represents only the first of several Latin markets that will move to mandatory, real-time electronic solutions.

Paulo Candido de Oliveria, executive director for the Brazilian Commercial Banks Association (ABBC), a Sao Paulo-based organization representing small- and midsize banks, says Brazilian banks will boost their investment grade by conforming payment systems to the requirements of the BIS, the International Monetary Fund (IMF) and The Committee on Payment and Settlement Systems (CPSS) of the central banks of the Group of Ten countries.

Others, such as Paulo Sampaio, superintendent of the National Open Markets Institutions Associations (Andima), a Rio de Janeiro-based organization representing firms trading in fixed income markets, says the process will make Brazilian banks mature. The banking market will be much healthier and much more responsible for its own problems, he says. We won't have to go to the Central Bank every time we have a problem.

Difficulties ahead

The difficulties of compliance, however, are compounded because non-private bank parties, including the Central Bank and clearinghouses themselves, are not yet fully ready for SPB.

For example, in late May Embratel/RTM consortium and AT&T Latin America, two telecommunications providers, were not yet connected to the network because they had so far failed to sign an agreement with Febraban, Brazil's principal bank association. The two operators will link the banks with private clearinghouses and the Central Bank's Reserves Transfer System. Agreement was reached in June.

It's quite crazy what's going on, says Yatsuda. We are developing the system while the Central Bank and the other clearinghouses are still defining the rules. He notes that Brazil has numerous clearinghouses, such as one responsible for the Brazilian stock market, another responsible for currency exchange and derivatives markets, and yet another responsible for payment systems. Some of these, such as the latter, have yet to formulate their own regulations or announce how they will operate.

JPMorgan's Lauretti also laments that the Central Bank has not proven to be the leader it should be. Up to this moment we don't have all the accounting procedures the Central Bank should be giving us. The Central Bank should be saying, that when this happens you should do this and that with accounting procedures, and they have not yet done so to my knowledge.

The Central Bank, like private banks, is changing its systems, as well as its regulations and is in dialogue with clearinghouses. For them, like for us, there are a lot of new things, says Lauretti. And they are demanding a lot, and sometimes they are not doing their homework as fast as they are demanding.

Moving from the batch system to SPB has proven fraught with difficulties. Brazilian banks were given less than 18 months to complete an enormous task. Compare that to the seven years, including three years to plan and four year to implement, it took Canada to make similar changes. Also, in Brazil back offices generally operate with many systems, creating a very complex environment, says Yatsuda. Consequently, integrating the payment systems with the legacy systems is difficult, especially given the fast-paced time frame. Garcia's estimate is it takes a full three to four months for a bank to implement the SPB system.

While the implementation process is proceeding, Brazilian banks must educate the public about SPB, since everything regarding payments that involves consumers, such as their current accounts, will change in some form. Though banks are beginning to explain changes to clients, Lauretti says awareness among the public is at only 20% to 30%.

Jose Eirado, deputy head of the information technology department of Brazil's Central Bank, says a medium-sized bank needs about three months to implement the new system, while to integrate the new system to its legacy system is another story, so each bank knows its size and its problems.

Eirado defends the Central Bank, pointing to the postponement in requiring full-fledged adoption of SPB from October 2001 to January 2002. And because banks now need to be ready for implementation in November instead of August, they have five months to test the new system instead of only two. Moreover, on June 1, the first testing date, Eirado says 82 banks participated, representing just over half of the 163 banks that will have to be connected to the new system. We believe for the first day the participation was massive, he says. In August all banks must have systems ready for testing.

Andima's Sampaio says the time frame is limited, yet reasonable. I think timing was very short but correct, he says. With Presidential elections (coming in 2002) it is never good timing. The Central Bank is not independent, but controlled by the government, so this movement could have been postponed because of political problems.

And Sampaio says that following years of consolidation, Brazil's banking system is robust enough to weather the shock of the system change. Today Brazil has 160 commercial banks and 360 broker dealers compared to 210 and 647, respectively, in 1994. Consequently, the financial players left standing in today's market are stable and should withstand the move to SPB.

Small banks' challenge?

The general consensus is most banks will be ready for SPB's full launch next January. Of Brazil's roughly 160 banks, the 20 largest banks and the 70 midsize banks are in good shape, but the remaining 70 small banks could be on shakier ground.

Larger banks, for which the effects of the SPB conversion will be the most profound, started preparing early for the change. Not so for banks with solely local concerns. Those banks, in contrast, initially didn't understand SPB or its impact, says Yatsuda. The uncertainty touched off a wave of rumors that some small banks would close or frantically try to merge but such fears have proved unfounded.

Not only do small banks, many of which have their top directors immersed in the project, now recognize the nuances of SPB, it is also clear the Central Bank will not kill off banks that are not ready by January. Those banks will simply not be allowed to execute transactions.

Of course, this alone is incentive enough for some small banks to consider merging to improve liquidity. Such mergers could further strengthen Brazil's financial system. To trade public bonds with the Central Bank, banks have to have cash to buy those bonds, says Sampaio. These are huge transactions in terms of amounts of money. Some banks will not be able to be in the market trading with such high volumes, so we expect that some banks will merge.

One indication in the recent merger between Senior, a broker dealer in the futures markets, and Agora, a broker dealer in the fixed income markets.

But small banks are expected to ultimately benefit from SPB, just as are large- or middle-sized Brazilian banks. The new system, Candido de Oliveria says, will give small banks a national rather than merely a local presence.

T4B's Garcia agrees, saying SPB will level the playing field. For small banks this is a great opportunity because by implementing SPB they will be in a situation where they can compete with big banks, especially in B-to-C and B-to-B businesses, he says. This is a big market in Brazil, but banks are not in the market of intermediating online right now. But, with SPB banks will be in the position to take advantage of this business. So banks, whether they have 1,000 branches or one floor, will be in the same situation to compete in this business, because physically you don't have to be there.

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