By Guillermo Parra-Bernal
SAO PAULO, Nov 26 (Reuters) - The outlook for Brazil's largest listed banks remained 'challenging' in the short term as loan growth in some segments nears saturation and the high cost of financial services crimps demand for new credit, analysts at Santander Investment Securities said on Monday.
Government steps to force a decline in borrowing costs and banking fees have yet to be accompanied with measures enabling banks to lose revenue without putting the brakes on new credit, New York-based Boris Molina and his team added.
The analysts also said the notion that Brazilian banks earn extraordinarily high profits is a 'widespread popular misconception.'
Low-income households are probably taking on less credit in Brazil because its cost has become almost prohibitive, the report said. Further volume will only come via lower interest rates and fees on financial services, they noted.
'The high price of financial services in Brazil represents a structural headwind to growth, in our view leading to volume saturation at lower levels of credit penetration,' the report said.
The report provided further evidence that a growth model based on credit expansion that former President Luiz In??cio Lula da Silva implemented and continued by his successor Dilma Rousseff is severely fatigued. Rousseff, who has been in power for almost two years, has pressed private banks to cut borrowing costs to record lows, but her strategy has had mixed results.
'The high cost of credit in Brazil is not a cause but a consequence,' the report said.
Brazilian banks are unable to cut rates as fast as operating costs rise due to a high tax burden, high equity fundraising costs and the increased difficulty in doing business in Brazil - which the analysts called 'a highly litigious society.'
'These costs are the banking incarnation of 'the Brazil cost' malady that afflicts many industries in the country,' it added.
AVOID BANCO DO BRASIL
Investors should avoid increasing exposure to shares in Ita?? Unibanco Holding SA, Banco Bradesco SA and Banco do Brasil SA, the report said, adding that the recent slowdown in loan growth seems to be structural, rather than temporary.
The analysts raised their rating on preferred shares of Ita?? to 'hold' from 'underperform' as loan delinquencies at Brazil's largest bank should decline in coming months. Bradesco remained Santander Investment's top stock pick among Brazilian large banks.
However, Ita?? is faced with a steep slump in revenue, which could limit the shares' upside potential.
Investors should avoid Banco do Brasil 'as government mandates to support growth via lower lending rates and fees put the bank at odds with minority shareholders.'
Bradesco fell 1.2 percent, while Ita?? shed 1.5 percent on Monday. The benchmark Bovespa index was off 1.2 percent.
Banco do Brasil rose 3 percent on Monday after it said it will list its insurance holding unit.
(Editing by Jeffrey Benkoe and Bernard Orr) Keywords: BANKS BRAZIL/SANTANDER
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