HISTORY OF BRITISH BANKS IN BRAZIL
Finance was the visible and crucial nexus which linked domestic activity in Brazil with international markets. These relations became especially important during the Brazilian First Republic, from 1889-1930. By the 1920s, Brazil was Latin America’s largest international debtor. British investment and commercial banks were prominent in Brazil; they influenced public policy, and provided commercial finance, access to European capital markets, and access to international distribution systems for coffee, during its years of most intense dynamism.
British financial activities reached their apogee and experienced notable decline during the First Republic. During the same period, the modern domestic financial system began to coalesce. British banks provided much financing to sustain international commerce and actively participated in shaping the Brazilian banking system. They also served the special function of conducting many of the transactions that linked international long-term capital investment, commodity trade and money exchange into an integrated global financial system. This paper considers the role of British commercial banks in the domestic economy during the First Republic. It also documents the decline of British presence during the period and considers the reasons for the decline.
In contrast to much of the existing economic historiography, this paper focuses on the business practices of banking in the private sector, rather than on federal monetary policy or government international long-term debt. Policy and international debt are considered for their effects on the private sector banking practices. Also departing from the general direction of existing historiography, this paper shifts the relative weight of explanation for the declining influence of British finance in the Brazilian economy from the shift in international economic relations toward development within the Brazilian economy and the inadequacy of British understanding of Brazilian political economy. The published balance sheets of foreign and domestic banks, archival holdings of the major British banks and the lively contemporary financial publications support these findings.
Banking in the First Republic
The Brazilian-British trading system, centered on coffee and finance, successfully created globally integrated and very efficient markets for coffee and money. Coffee was the product that most prominently connected Brazil to international markets during the First Republic. A variety of other agricultural commodities – cotton, cocoa, and sugar – also contributed to Brazil’s reputation for providing tropical products to the wealthier northern countries. For a short period at the beginning of the First Republic, rubber provided a lucrative source of trade, before meeting with a spectacular crash. But these commodities did not influence financial structure to the extent of the coffee trading network.
Financial institutions were the nexus that allowed Brazilian coffee and the economy to become internationalized. The coffee trade often influenced government policy; it also motivated industrialization and overall economic growth. Although the benefits of commodity production for export did not extend to a majority of the population, prosperity was strongly identified with coffee. Large scale coffee cultivation for export began in the middle of the nineteenth century, and grew rapidly in volume and importance. From 1889 to 1930, Brazil produced 71% of the world’s coffee. (See Table 1.) By the twentieth century, coffee production occurred within a geographically concentrated area; crop land in the state of São Paulo produced almost one half of the world’s coffee supplies at this time. (See Table 1.) The markets for coffee were dynamic, responsive to market forces, and international in nature by the beginning of the twentieth century.
Coffee valorization demonstrated producers’ ability to assert their strength in global markets. However, by the end of the First Republic, persistent over-supply of coffee resulted, at least for British financiers, in the belief that: “large crops bring no benefit to Brazil: on the contrary, they entail expense of holding a larger stock.”
In its early stages, expanded coffee production required relatively little capital and import/export merchants attended to the necessary financial arrangements of extending short-term credit to bridge the needs of each stage of the production and trading cycles. Separate financial institutions were not necessary to accommodate commercial needs.Indeed, attempts to establish domestic banks did not succeed prior to the end of the nineteenthcentury. However, the rapidly growing coffee trade significantly increased demands on the financial system. By the end of the nineteenth century, the volume and risks of coffee financing were sufficient that coffee merchants were anxious to remove themselves from financing the commerce. Small domestic commercial banks appearing at the end of the nineteenth century partially filled the need to finance Brazilian merchants. Segmenting the separate activities of the coffee trade separated the risks of production, foreign currency exchange fluctuation and finance.
The separate activities were broadly aligned with nationality. Brazilian producers cultivated beans. British and increasingly Brazilian banks financed the cultivation and export.
The United States and Germany were the largest consumers of Brazilian coffee. Further, the exponential growth of territory and labor committed to coffee cultivation which occurred simultaneously with the establishment of the First Republic transformed the demand for physical infrastructure. The railroad construction, port expansion and urban improvement that accompanied the growth of the coffee economy required expanded access to long term capital. The investment in infrastructural development largely originated in the London capital markets. At the beginning of the First Republic, infrastructural development, investment, the expansion of domestic markets and the expansion of the financial system closely matched the exigencies of coffee and trade.
From its inception in 1889, the financial structure of the First Republic suffered periods of severe disruption. Beginning in 1892, shortly after the abolition of slavery and the monarchy, an unbridled financial expansion led to a crash, widespread corporate and bank failure and a prolonged depression. The London investment banking house of the Rothschilds underwrote a loan to re-finance the Brazilian government debt in 1898, supporting the subsequent stabilization policies of Joaquim Murtinho. The conditions of the Refunding Loan severely constrained the government’s discretion in fiscal and monetary policy. These conditions pledged customs revenues to loan repayment, restructured ownership of government infrastructural investments, imposed expenditure constraints, and implemented a metal standard. Partially due to the very restrictive conditions of this loan, a series of bank failures followed in 1900 and 1901, rendering the banking system virtually inoperative.
During the subsequent four years, British commercial banks were the major providers of financial services in Brazil. Widespread restructuring of the failed banking system during 1905 and 1906, resulted in a substantially reformed financial system. The 1906 coffee valorization program influenced the timing of the banking reforms. The state of São Paulo negotiated an international loan of £3 million, guaranteed by the federal Treasury to finance the price support program.
The complicated negotiations for this loan, which was not issued until 1907, generated controversy within Brazilian financial circles. The Rothschilds, the usual bankers for the Brazilian government, declined to participate in this arrangement. Although the loan was ultimately issued, other investment bankers and the domestic financial community shared their concern about the effects of the valorization on the value of the mil-réis. At the end of 1905, the Banco do Brasil was re-chartered, as the successor to the Banco da República, the Treasury’s agent bank, (which led the failures in the 1900 crisis). A major component of the banking reform and organizational structure of the Banco do Brasil was the establishment of a Conversion Office within the bank to implement a metal standard, in an attempt to reverse the long-term decline of the mil-réis, which was expected to continue with the valorization.
Two considerations dominated the debate about valorization and the metal standard. The first was the ability of paulista producers to successfully affect world coffee prices. In this regard, they were relatively successful, as noted above. Determining the exchange rate which the Conversion Office would maintain was the second important issue of the debate. The two most visible economic concerns of the country had opposing interests in this question. Low exchange rates (£/mil-réis) favored exporters, but impeded the Treasury’s ability to meet its international debt service burden and fueled domestic inflation. Supporting the mil-réis was intended to ameliorate the inflationary effects of the 1906 coffee valorization program. Ultimately, the Conversion Office supported a rate of 15 pence/mil-réis.
Although the rate of 15 pence was a slight appreciation in the value of the mil-réis from the rates realized in the currency markets, it was the first official revision from an official par value of 27 pence in 1847. At least until 1914, this rate was somewhat below that which currency markets supported.While often interpreted as an indication of the political strength of the coffee sector, these arrangements also set the framework for renewed domestic banking expansion. These countervailing interests were the core of the most intense political economy debates during the First Republic.
The reforms to the financial system revitalized commercial banking. The newly-constituted Banco do Brasil acquired some functions of a central bank (though not, at this time, as a lender of last resort). In addition to administering the metal standard, the bank was the agent for the federal government’s financial transactions. The most profitable of its privileges were tariff collection (paid in hard currency), monopoly rights to conduct the Treasury’s foreign exchange transactions, and a federal charter allowing it to establish branches across state boundaries. Simultaneously with its public sector functions, the bank had the largest private sector credit portfolio.
In contrast to earlier years, privately owned commercial banks engaged solely in financing shortterm commercial transactions with rigorous procedures to protect against the risks of borrowers’ failures. They funded their short-term investments with their own capital and deposits, rather than issuing notes that created insecure future liabilities. Amended bank statutes and regulation precluded direct engagement in long-term finance and the issuance of unfunded notes. Risk minimization was an explicit and on-going goal of bank management. These characteristics were common to all publicly chartered banks, whose equity shares traded on the securities exchanges. Enhanced stability and legitimacy accompanied the reforms that restructured the banking system in 1906.
British banks in Brazil
British banks were perhaps the most prominent institutions spreading European business interests in Brazil. Both investment and commercial banks were very active. Although, they had overlapping interests, they financed different types of activities and incurred risks of different natures. British investment banks, most notably represented by the Rothschilds family banking house, did not invest in or lend to Brazilian borrowers; nor did they necessarily raise “British” capital. The investment houses merely sold to investors the debt issued by the Brazilian government. In a narrow sense, they were simply brokers to place Brazilian debt with investors either in London or in other European financial markets, through continental partnerships. Even so, investment and commercial bankers had in common the function of providing for flows of finance which connected the different individuals, organizations, activities, economic sectors and geographic regions.
British investment and commercial bankers seemed to share opinions on appropriate financial structure and business procedures. From their appearance in the mid-nineteenth century, British commercial banks engaged in business of a relatively consistent nature. Three banks of British origin were prominent from the middle of the nineteenth century to serve British export merchants. The London and Brazilian opened in 1863; and the British Bank of Brazil started in 1864; and the London and River Plate began Brazilian operations in 1892. The first two banks merged into the Bank of London and South America (BOLSA) in 1923. BOLSA acquired the British Bank of Brazil during the 1930s. Finally, in the 1960s, Lloyds Bank acquired BOLSA. British commercial banks, with their long history of trade finance, ties to European markets, and early establishment benefited from the specialization of commercial finance.
At the end of the nineteenth century, the credit businesses that Brazilian and British banks conducted were dissimilar. During the nineteenth century, small groups of business associates owned the few (and short-lived) domestic banks, which offered them the opportunity to combine commercial and investment financing and to undertake equity investment in the partners’ other business enterprises. At times, the Treasury granted specific banks the right to issue notes based on their own creditworthiness. When granted these rights, the domestic banks used them actively.
Foreign and domestic banks provided short-term credit to span the period between a merchant’s acquisition of a tradable commodity and the receipt of revenue from selling that commodity. They advanced credit by purchasing at a discount commercial paper guaranteed by the commodity (typically coffee) or the personal guarantees of the merchants. If the client defaulted, the bank had recourse to the payment from the original mercantile transaction on which the client had originally based the note. By providing on-going services for their clients, these short term arrangements could be effectively converted to long term financing, to the extent desired.
By 1906, once chartered, laws, regulation and taxation did not consider foreign banks differently from their local counterparts. However, the nature of financial regulation offered foreign, and especially British, banks effective advantages not available domestic organizations. The two most important areas if difference were with respect to conducting foreign exchange transactions and obtaining national bank charters.
British concerns appeared to be more risk-averse than their local counterparts. They limited their business to short-term, fully-funded, self-liquidating commercial transactions, especially in the foreign exchange market, in order to minimize their risks. Because “speculative” foreign exchange transactions were illegal after 1900, regulation prohibited foreign currency transactions which were not associated with specific commercial transactions. Therefore by servicing their compatriot export merchants, British bankers had an effective advantage in the sector of business which heavily required the exchange of currency. The British organizations earned a large share of their revenues, and conducted a large portion of their business by simply exchanging currencies, which involved no risk of credit exposure.
In doing so, the banks profited both by the fees they charged and by their ability to realize gains from fluctuations in currency values. The money market for currencies was active both in London and Brazilian financial centers. By the beginning of the twentieth century, British banks telegraphed to their head offices the prevailing exchange rates at least daily. They aggressively pursued arbitrage opportunities to profit from exchange rate differentials between the locations. British commercial banks displayed a reluctance to extend credit, and only slowly extended their activities to include the extension of credit in the form of general purpose loans with personal guarantees. Although potential borrowers decried their risk-averse behavior, often with nationalistic overtones, British banks and their domestic counterparts clearly preferred the relative safety of exchange transactions, as compared to credit exposure.
British banks only gradually modulated their different perspective on the nature of lending at this time and continued to benefit by their preference for the relative safety of their currency exchange activities. Further, when extending credit, British commercial banks assessed their risk somewhat more severely than did their domestic competitors. In 1907, while the business community decried a debilitating lack of credit, a British consul reported that a “notable feature of the banking business during 1907 is the heavy amount represented by discounts and loans.”The British described much of the credit extended by Brazilian banks as accommodation notes, short-term credit extended to borrowers based on the personal relationship between the borrower and the banker.
This form of lending was often seen as an expression of inefficient or “uneconomic” personalism. From the perspective of Brazilian bankers, however, a decision to extend credit secured by personal relationships could be an effective means of protection in an uncertain environment. Interestingly, however, the credit portfolios of British banks did not match their rhetoric. For the entire period from 1906 to 1930, the distribution of credit between personally guaranteed short-term loans and purchases of discounted commercial paper was more heavily oriented towards loans for British banks than for the Brazilian organizations. (See Graph 2.)
The second advantage accruing to British banks after the 1905 reforms was their ability to retain national bank charters, rather than the state charters which domestic banks acquired. Domestic banks required individual state approval and capital allocated to each office, as though each charter represented a separate institution. Foreign banks only needed one national charter which specified the number, but not location, of separate offices. British banks, with their very early presence in Brazil, were the clear beneficiaries of this arrangement. Each office within the British organizations shared information; they coordinated total credit limits to manage exposure to clients, shared financial and political information, and pooled their funding. Prior to the national expansion of the Banco do Brasil (slowly beginning in 1908), a consistently operating national bank was not reliably available in Brazil. Arrangements for noteissuing, deposit-taking, and funds transfers had been regional in nature.
British banks offered one of the most expeditious ways of transferring funds inter-regionally. British banks competed among themselves for regional representation. Pooling deposits of total resources to their most attractive opportunities, with little regard to geographic location. They also competed for the ability to expand to new regions. For example, while rubber was still profitable, the Bank of London and Brazil worried when the London and River Plate opened a competing office in Manaus, the major rubber commercial center. In 1910, the London and Brazil complained that it had more difficulty obtaining permission to open local offices than the London and River Plate.
Even so, with the opening of the Banco do Brasil as a national bank, the London and Brazil did not initially competitive expect pressure on its local commercial business from regional Banco do Brasil branches. Despite their implicit advantages, economic growth and exchange rate stability British commercial banks were dissatisfied with the results of the 1905 reforms for their activities within Brazil. The benefits which the Banco do Brasil received from its quasi-public position were constant sources of complaint. Foremost among these benefits were its monopoly on foreign exchange transactions from the Treasury and customs collection. Notwithstanding these complaints, the commercial operations of the restructured banking sector which emerged after 1905 was, in form, very similar to its British counterpart.
British bankers’ understanding of the political economy
Notwithstanding the long and influential history of British commercial banks in the Brazilian financial system and the system’s increasing stability, British bankers did not master the political economy of their environment during the First Republic. During the early period of bank restructuring and expansion, the Bank of London and Brazil, with the longest record in Brazil, made fundamental different offices, the banks maximized their business and enhanced their regional presence by allocating errors of judgment with respect to the political economy. In 1907, they did not expect the newly constituted Banco do Brasil to survive; nor did they expect that the Treasury would support a federal guarantee for the coffee valorization loan. They professed to be surprised by the loan, even when it was eminent. They further expected that the administrative bureaucracy of the procedures for maintaining the metal standard would not survive.
A few years later, rather surprisingly, the Bank of London and Brazil did not expect the British ban on coffee and cocoa imports, because of the financial and shipping demands of the military during World War I, to be important for Brazil. “After all, the USA is the largest purchaser of your [Brazilian] coffee and European neutrals appear to have all they require for some time to come …” This response did not consider the complexity of the trading system in which they participated. The British-centered financial network supported a coffee trade that was very diverse. Germany had been the second largest importer of Brazilian coffee. Closing that market jeopardized the financial viability of the coffee trade. It also did not consider the additional difficulty that the London money market was also closed for Brazilian commercial paper and currency, making business transactions impossible. Within Brazil, the weakness of their political judgment did not prevent British bankers from an intimate involvement with the business community. Although slow and modest in scope, from the 1910s, they began a shift toward financing Brazilian domestic enterprise, such as the textile and other consumer goods industries and domestically- oriented infrastructure projects. These circumstances occurred during the years from 1914 until the early 1920s, when World War I constrained access to international markets and domestic financial markets became expansive.
Monetary expansion through Treasury note issuance and the Banco do Brasil Rediscount Office fueled domestic expansion.62 Although these policies had a relatively small effect on the private sector, at the time, commercial banks broadened their presence in sectors beyond agriculture. British banks increasingly participated in lending consortia and rescheduling arrangements for failing or troubled local concerns.63 British banks also became more active in issues related to the structuring of the Brazilian domestic banking system. As one instance, in 1914, foreign bankers actively organized efforts to establish a unified bank lobbying position to respond to the Treasury’s foreign debt restructuring proposals, with significant leadership from the London and River Plate.
The collapse of global commodity markets and international financial stringency threatened the viability of these expansive policies at the end of World War I. Increasing international and domestic debt burden, price inflation and the strong global post-war slump in commodities diminished the financial options for the Brazilian government by 1923. Through the mid- and late-1920s, the Brazilian economy was under pressure. Reflecting economic and political realities, orthodox monetary policies regained political strength. At the end of 1922, a new government based its strength largely on an orthodox platform of tightened monetary policy and financial restructuring.
The Montagu Mission, representing the investment houses of the Rothschilds, Baring Brothers and Schroders, undertook a study of Brazilian public finance in order to support a loan intended to restructure public debt in 1924. Despite the convergence of goals between British financiers and government, issues of national sovereignty were not far from the surface. The Montagu Mission considered the question of maintaining a foreign financial oversight presence in Brazil. This point raised considerable opposition in Brazil.
The Treasury Minister’s reaction to such a proposal was that: he would rather abandon all hope of restoring the financial position of Brazil than consent to the ‘fiscalization’ of the Treasury … no Government that consented to it could live.
This period of economic contraction and restructuring coincided with the re-emergence of privately owned domestic banks as a strong force in the commercial sector. Nevertheless, the British commercial banks focused on the contractionary aspects of their environment, and lowered their public profile. Internal communications focused on transferring funds among regional offices in order to accommodate credit commitments in a contracting banking system.
The benefits of inter-office transfers of funds were strongly demonstrated during 1924 and 1925 when monetary policy was severely contractionary. By actively managing their funding, the banks maintained their credit portfolios more than would have been the case otherwise. However, increased attention to allocation of funds among regions did not signify growing markets, as it had in earlier years, as much as it indicated more acute management. One telegram mentioned “the lack of safe and profitable investment and the consequent large cash holdings that practically every bank shows” Under these circumstances, foreign exchange trading also received renewed attention. From 1923 to 1930, in Brazil, the Bank of London and South America (BOLSA) offices earned between 42% and 120% of their operating profits from foreign exchange operations. (See Table 2. Consistent data are not available for a longer period.) These profits often subsidized new offices and loan losses.
The pressure on public finance and the consolidation of the banking system continued through the remainder of the 1920s; and the financial situation remained precarious. The severe deflationary monetary policies (partially associated with the Montagu Commission recommendations) were in effect until 1926. They were followed by a sharp domestic recession, largely due to contraction in the textile industry. Immediately thereupon, came the global depression of 1929, which resulted in capital flight from Brazil and depressed international coffee prices. By the end of 1929, the benefit of allocating funds among branches had reached its limits. As deposits contracted in reaction to the uncertainty of the times, individual branches were unable to release funds to other branches. London management permitted widespread overdrafts for the first time.
From the middle of June 1930, BOLSA officials in Brazil played down the political unrest which anticipated the coup of October. Local staff dismissed the seriousness of uprisings in the states of Paraíba and Rio Grande do Sul, and did not recognize the paralysis of the state government’s finances in Minas Gerais as a political event. At the same time, the Treasury removed exchange restrictions.The anticipated depreciation of the value of the mil-réis caused all banks immediately to withdraw available funds. Exercising their advantage in the foreign currency markets, BOLSA branches converted their milréis and shipped as much gold as possible out of Brazil, to London or New York. By this time, the federal Treasury’s request for help to halt the outflow of gold had no credibility with BOLSA management. Curiously, despite widespread political upheaval as a likely explanation of the capital flight, the first specific recognition that a coup was likely occurred on 3 October, 1930, one week before the event.
In 1931, seven years after the Montagu Mission, the Niemeyer Mission conducted another advisory trip to Brazil to propose changes in the structure of public finances. The circumstances of this mission differed significantly from efforts in 1924. Rather than an abrupt end to an expansionary period, the Brazilian economy had suffered seven years of intense pressure. Under these conditions, potential lenders insisted on a comprehensive study of the financial system with recommendations for improvements as a prerequisite for another debt restructuring and increased borrowing. The Niemeyer Mission proceeded despite the coup. The recommendations of the Niemeyer Report in 1931 had the support of the traditional commercial press. However, they lacked political support necessary for implementation. Despite initial lip-service to the commission’s report and its orthodox policy prescriptions, its recommendations were not adopted.
The new regime of Getúlio Vargas subtly, but quickly, showed protectionistic tendencies. Indications that the Vargas Government either could not or did not intend to implement the recommended reforms came early. In fact, the initial appearances of accepting the Niemeyer Mission recommendations radically reversed within a year, when the Vargas Government announced a moratorium on its foreign debt in 1932. These actions supported the coffee interests concentrated in São Paulo. More intriguing, however, they supported the interests of emerging import-substituting manufacturing, also concentrated in São Paulo. They presaged later and more explicit development policies, based on protection of new import-substituting industries.
Competitive pressures
Further challenging their position in Brazil, British banks faced vastly increased competition from a variety of sources. At the end of 1906, immediately after the banking reforms, British banks represented about 16% of the banking sector in the major financial centers, as measured by size of their deposit base. By 1930, these same banks accounted for 7% of bank deposits. (See Graph 3.) Credit extended by British banks increased four-fold between 1906 and 1930 in real (inflation-adjusted) volume; while private domestic bank credit increased more than seven-fold. (See Graph 4.)
Rumors had circulated throughout 1923 of the possible merger of the London and Brazil with the London and River Plate. The Bank of London and Brazil denied the possibility as early as January; the banks announced the merger in November. The motivation for the merger had been to consolidate two organizations which were very similar, and had not been growing at satisfactory rates. Changes to bank management policies did not accompany the new corporate structure; credit-issuance and deposit-taking continued without noticeable change. By the 1923 merger, the newly constituted bank had offices in fourteen widely dispersed locations.90 Through 1924, they consolidated separate banking offices, staff and administrative arrangements. However, internal communications mentioned no changes of banking policies.91 The ease of the merger reflected the similarity of the practices and businesses of the institutions. Despite an easy merger, British banks did not reverse their relative decline. (See Graph 3.)
The declining role of Britain in Latin American economies after World War I, 92 reflecting a relative shift of international financial importance towards the US, may not have been as pronounced as generally believed.93 At least as important as changes in international economic positions, the relative decline experienced by British commercial banks reflected the growth of the Brazilian economy and the domestic banking system. As the First Republic progressed, the declining importance of British financial institutions reflected the growth and diversification of the domestic economy.
The evolution of the Brazilian economy made possible the shift in the type of financing that accompanied the change in its national origin. Important sectors of the economy were more committed to domestic than international markets. A significant portion of domestic development during the First Republic occurred in the realm of early industrial manufacturing. Between 1900 and 1930, industrial production increased 4.6 times, while all agricultural production (including coffee) increased 2.8-fold. Further, available evidence suggests that the areas of most dynamic economic growth during the last decades of the First Republic were regions supporting domestic, rather than international, markets.
Domestically-owned private banks also grew rapidly in number and size at this time, even after accounting for inflation and the formation of state government banks accelerated in the early 1920s, in response to the expansive conditions. After strongly expansionary rediscount programs which shifted business to the Banco do Brasil from 1914 until 1923, private domestic banks re-emerged dynamically for the remainder of the decade. Brazilian owned banks increased their share of private bank deposits from 35% in 1921 to 53% by the end of the decade. (See Graphs 3 and 4.)
Production for domestic markets developed to a scale and complexity that it required and supported more dynamic financing arrangements. Brazilian-owned commercial banks accommodated these financing needs at least as well as their British counterparts. They did not require as much access to foreign exchange markets as the export trade, which had been the historic strong-point of the British organizations. Further, Brazilian organizations responded more sensitively to domestic conditions. As domestic concerns required financing, and accepted the ability of Brazilian organizations to meet those needs on an on-going basis, short term finance shifted towards domestic banks.
Foreign banks of other nationalities were another major source of competition for the British. The growth of manufacturing capacity to accommodate the increasing demand for consumer goods supported the growing predominance of direct foreign investment in emerging industries. General Electric, RCA, IBM, Ericsson, Philips, Burroughs, Pirelli, General Motors and Ford were some of the corporations investing and producing in Brazil for the use of the domestic economy by the end of the 1920s.
The presence of transnational corporations accommodated both the presence of a wider variety of nationalities among foreign banks and the relative decline of portfolio investment in financial assets.The share of deposits in the Brazilian banking system from foreign banks not of British origin increased from 14% in 1915 to a short-lived maximum of 35% in 1920; and the real volume of foreign bank credit grew at the same rate as the domestic banks through the First Republic (though with greater fluctuations. See Graphs 3 and 4.) During the 1910s and early 1920s at least nine foreign banks opened offices in Rio de Janeiro or São Paulo. Although not all of these organizations had long or successful lives, they increased the sense of competition and dynamism for commercial banking during the 1910s and early 1920s.
Effects of British banks in Brazil
Throughout the First Republic, the importance of British commercial banks extended beyond the financial services they provided to the business community. The British system served as a model for the structure of the evolving Brazilian system in two especially important ways. The separation of commercial and investment banking emerged without debate after widespread bank failures at the end of the nineteenth century. Further, the long battle to establish a central banking authority received impetus from the British experience and from British “money doctors.” British banks and bankers actively participated in the evolution of the Brazilian banking system.
The domestic British commercial banking system demonstrated the uses of such mechanisms as discounting, specific management tools (credit limits, valuing inter-branch fund transfers) and establishing an inter-bank clearing house to expedite the transfer of funds between banks. With time, the business activities of domestic and British banks converged. As compared with their business in foreign exchange, the credit portfolio of British banks became increasingly important and more oriented towards general purpose loans, following the example of their domestic counterparts. Although unintentional, the national networks of British banks constituted an early proto-national banking system, which other banks ultimately emulated.
The economic constraints of the 1920s and increasing domestic competition entailed significant erosion for British commercial banking. During the late 1920s, the directors of the Bank of London and South America appreciated that they needed to re-consider the form of business that they conducted in Brazil. By 1933, they recognized that the bank needed to shift its emphasis from facilitating trade transactions, avoiding credit, to develop a business more firmly rooted in lending funds:
…in 1929/30 there was a general tendency to increase loans and discounts. This tendency was not, I am quite certain, the result of a decided policy by the Board, but rather the lack of any policy or of any control or consideration of the general rise in advances. To avoid this in the future I think that we should have laid before us a summary, … We shall almost certainly have to rely more and more in the future on our Banking profits rather than exchange profits, and good management and control will become more essential.
The increase of loans and discounts in 1929 and 1930, mentioned above, was relative to the bank’s base of deposits available to fund credit. In absolute volume (adjusted for price level fluctuations), credit remained virtually constant. (See Graph 4.) Notwithstanding these changes, by the end of the First Republic, British finance had profoundly influenced the Brazilian financial system. Especially in the earlier years, British banks provided a significant volume of short-term commercial finance and they offered the model for developing a commercial banking system. Brazilian law both prohibited explicit legal discrimination by nationality in business and increasingly legislated for a structure of commercial banking law similar to the British model. Finance flowed freely between Europe and Brazil, and supported a dynamic trade in agricultural commodities (notably coffee). This system was fundamentally disrupted only once between 1906 and the end of the First Republic.
During World War I, exogenous disruptions of trade and finance caused coffee and money to be locked in their locales of origin. The exogenous disruption provided an impetus for domestic financial development, with ample British participation. Even so, the end of the First Republic coincided with indications that this system was no longer viable. The convergence of policy and structure may also hold the key to understanding the demise of this system. Adjustment was uni-directional. Changes to monetary systems, legal structure, fiscal policy occurred in Brazil, moving toward conformity with the British system and in order to accommodate financial and economic requirements administered (or implied) by British financial representatives.
British investment banks suffered a fate parallel to that of the commercial banks. Pledging customs revenues, maintaining a fixed exchange rate on the metal standard, adopting budget constraints, developing institutional structures to administer and meet these goals had been among the more important steps that Brazilians took in order to take advantage of London capital and money markets. US investment banks issued Brazilian debt to US investors under more expansive conditions, and for more diverse purposes. Further, the growing predominance of direct foreign ownership of productive capacity, rather than portfolio investment in financial assets, rendered the activity of investment banking less important.
Symptomatically, despite their long and increasingly deep experience, British bankers suffered a disadvantage in Brazil. They did not become well versed in the political economy of their environment. Monetary policy was the core of profound political difference and debate throughout the First Republic However, British bankers did not display a deep understanding of the political tensions inherent in the differences of interests; and turns of political events often left them surprised. In large part, one can hypothesize that the interests of British finance in stability and maintenance of the profit dynamics of the commodity and money trading system remained constant, and it did not adapt to the changing realities of the Brazilian economy.
At the same time, and at least as importantly, the significance of this business system was very unevenly distributed. While it was very visible and important to the Brazilian economy, the same claim could not be made about the importance of Brazilian business relations for the British economy. The existence of these relations may have been important for some British bankers and merchants; but the effect on the British economy was insignificant compared to the qualitative and quantitative effects for the Brazilian economy. However, the imbalance in the distribution of benefits and policy accommodations between Brazil and Britain, and the concentration of benefits to small sectors of the populations of both economies, suggest that these relations remained viable only until they were challenged by emerging economic interests.
Conclusion
By 1930, the economic and political structure of Brazil was very different from the beginning of the First Republic, and the perceived benefit of accommodating the British financial market had lessened significantly. Brazil’s comparative advantage in agricultural commodities and, more importantly, the desire to maintain that comparative advantage were under increasing pressure through the early twentieth century. With industrial manufacturing and domestic markets gaining importance in the economy and nationalistic interests gaining political ground, the predominating influence of the coffee sector faced serious challenges. Investment in industrial capability grew, and increasingly took the form of direct, rather than portfolio, investment. Therefore, the perceived need to accommodate financial negotiation also shifted.
Government policy was increasingly willing to impose protective tariffs in support of domestic industry and to institute debt moratoria, rather than submit to the requirements imposed by rescheduling debt. The private domestic commercial banking system grew dynamically during the first third of the century, as its organizations more flexibly and reliably accommodated local requirements. The original relations were of decreasing importance.
British commercial and investment bankers continually assessed their circumstances in Brazil relative to their original relations because their profit dynamics remained relatively stable. For Brazilian business, however, the success of earlier activities for economic development and growth changed both the volume and composition of demand and the relative prices of goods and services. Producing for an enlarging domestic market, both to substitute for imported goods and to provide low-value consumer goods became increasingly viable. British financial and commercial networks did not accommodate the fundamental shift in the balance between domestic and international markets in Brazil.
See also: British Business in Brazil 1850-1950
By Gail D. Triner(Department of History Rutgers University, New Brunswick NJ, USA) originally published in July 2002. Revised version available in http://www.rci.rutgers.edu/~triner/Session102/Triner.pdf
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