OREANDA-NEWS. April 21, 2015. New and ongoing anticorruption investigations have created a more intense litigation environment that could add headwinds to Brazil's banks over the near term, says Fitch Ratings.

The new investigations cast further uncertainty on the already established Lava Jato investigations involving Petrobras and several of Brazil's largest corporations, and the long-running savings account class action suits related to economic plans of the 1990s, which are still pending a final decision from Brazil's Supreme Federal Court. (Previous Fitch commentary on the savings account cases can be found here.)

The most recent investigation to strike Brazil is a large corruption investigation regarding tax evasion crimes and bribes paid to Brazil's tax appeal board, or CARF. A number of large corporate issuers and some of the largest Brazilian private banks have been rumored to be involved in hiring consultants and law firms accused of making payoffs to board officials in exchange for favorable decisions from CARF on tax disputes. The investigations are still in their initial stages and there is limited information on the extent to which specific institutions are being and could be directly implicated. All the banks noted by the press as under investigation have denied wrongdoing and have yet to even acknowledge being formally investigated thus far.

It is too early to determine the ultimate impact of this new investigation for banks in Brazil. In most of the cases, the risk is the reversal of a favorable decision made by CARF on banks' tax disputes. In most cases, tax dispute reversals would not likely be material credit negatives for the banks. However, the burdensome and lengthy legal process in Brazil could prolong these disputes for years, adding operational costs.

On a positive note, Brazil's latest anti-corruption law (law number 12.846/2013), enacted in March 2015, is establishing a more aggressive tone for enforcement actions. The law is applicable only for corruption crimes committed since 2014, and should bring more strict corporate governance for banks and corporations in Brazil, as the law raises the penalties and the personal liability of executives involved in corruption schemes. A number of incentives for companies that collaborate with corruption investigations and heavy financial penalties for companies liable for involvement in corruption schemes should also help discourage corrupt practices.

The newest law's primary distinction is its definition of punishment and signs that its enforcement will be strictly applied. The law outlines that an entity can be punished by paying fines ranging from 0.1% to 20.0% of its gross revenues, depending on the severity of the infraction.

Fitch believes that the anticorruption law, if implemented effectively along with more robust corporate governance practices, is a long-term positive for the Brazilian banking system.

Overall, if a bank's involvement in a corruption scheme is proven, it could cause serious reputational damage to the franchise and lead to risk aversion from investors and clients, ultimately resulting in pressure on its ratings.

Brazil's strong regulatory framework, active supervision by the Brazilian Central Bank and the implementation of Basel III requirements are factors that should help Brazilian banks absorb any financial burden stemming from this potential risk. Other possible outcomes include strengthening of operational risk, compliance and internal controls.