Brazil wants shareholders to pay for rescue of troubled banks

(Reuters) - The Brazilian government, concerned about systemic risk in the rapid growth of banking assets, will propose legislation to make shareholders, bondholders and depositors pay for rescuing troubled banks and shield taxpayers from the cost of bailouts.

Central Bank President Alexandre Tombini told a banking seminar on Monday that the legislation aims to mitigate "moral hazard" by forcing banks to assume full responsibility for their losses in what is known as a "bail-in." It was applied in Cyprus to stop a run on the banks and Canada is also considering rules to deal with potential bank failures.

In the case of Brazil, the proposed bill underscores mounting unease among regulators with the rapid pace of growth of banking assets in Latin America's largest economy in recent years. Some banks might be "too big too fail" in Brazil, and the need to discourage irresponsible behavior could be higher now than before as state-run lenders expand their balance sheets three times the pace of their private-sector peers.

The proposed legislation still has to be reviewed by several cabinet ministries before being sent to Congress.

Tombini said that while Brazil's banks are solid and currently have the necessary capital to pay for credit-related losses, the legislation would call for large, uninsured depositors to help bolster the capital of ailing banks.

"One key goal here is to ensure financial stability and mitigate any negative externalities stemming from a credit event on the real economy, making sure the infrastructure of the financial system continues to function," Tombini said.

In recent months, loan delinquencies in Brazil have fallen from record highs after year-long approach by private banks such as Itaú Unibanco Holding SA (ITUB4.SA) and Banco Bradesco SA (BBDC4.SA) to avoid riskier loans. On the other hand, state-owned banks like Banco do Brasil SA (BBAS3.SA) and Caixa Economica Federal CEF.UL have raised lending to help President Dilma Rousseff's administration improve a slow economic recovery.

The discussion about "bail-in" measures comes after governments in Europe and the United States rescued dozens of troubled banks with taxpayers' money in the aftermath of the global financial crisis of 2008. Critics said those banks should have been held more accountable for their risky business.

The European Union is also discussing proposals for shareholders and some depositors to take on losses of failed banks, following decisions in Cyprus for depositors to take losses in return for an international bailout.

Some economists have said that bail-in schemes could lead depositors to stay away from the financial system or simply deal with the safest institutions, shunning small banks and hampering competition.

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