OREANDA-NEWS. Brazil's small and medium-sized banks have had to revise their business models to cope with the tough operating environment, says Fitch Ratings. The success of Brazil's second-tier banks, which number around 50, most of which provide a similar and limited range of products and services to retail and commercial customers, largely depends on a supportive operating environment.

These banks tend to grow rapidly and perform well when economic growth is strong, credit demand is high and wholesale funding markets are open. But domestic demand has collapsed and we forecast a 3.3% economic contraction in 2016, on top of the 3.8% contraction in 2015, with a recovery in 2017. This is hurting the smaller banks, which rely on buoyant credit growth and low impairment charges to cover their operating costs. Performance indicators are weakening and, with some exceptions like Banco Daycoval and Banco ABC Brasil, many rated second-tier banks reported poor results or operating losses in 2015 and 1H16.

International ratings for 11of the 13 rated second-tier banks are on Negative Outlook, in line with those on the country's banking sector and the sovereign rating.

Growth prospects for the second-tier banks over the short term are limited, due to recession and the large banks' movement into some of their niche areas, such as payroll lending. China Construction Bank (Brasil), Banco Sofisa, Banco Daycoval and Banco Indusval have either completed, or are in the process of, delisting their shares from the local stock exchanges. They believe they will not need to access the capital markets, which is generally easier for quoted companies, in the foreseeable future. Delisting will also save on costs as quoted companies have to publish financial statements more frequently and maintain a regular supply of information for investors. On its own, delisting does not affect the banks' ratings and has no impact on the flow of information supplied to us in connection with our rating process.

Share price valuations for second-tier banks are normally low and trade below book value which makes it easier to buy back the shares. Shares of the country's largest banks trade above 1.7x book value.

Other strategies adopted by second-tier banks to cope with the difficult operating environment include establishing partnerships with top-tier banks, selling out to larger institutions, cutting back on services provided and cost-cutting.

Prospects for Brazil's banks will be discussed at a conference hosted today by Fitch's Sao Paulo office.