February 26, 2014 12:46 PM

SAO PAULO, Feb 26 (Reuters) – Brazil’s second-highest court was set on Wednesday to resume hearing a landmark case dating back two decades that could significantly reduce the capital of the country’s biggest banks and further trip up an already flagging economy.

Justices at the Supreme Court of Justice (STJ) will discuss the scope and time frame of lawsuits claiming that banks failed to pay fair interest on deposits between 1987 and 1992, when hyperinflation led the government to peg savings rates to a number of consumer price indexes.

The STJ will assess who qualifies for compensation and the time period for which additional interest should be calculated, which are crucial to estimate potential losses. Banks could pay up to 341 billion reais ($145 billion) in compensation if the ruling goes against them, banking industry group Febraban said.

The case underpins the legal uncertainties that abound in Brazil, where tax and regulatory disputes with the government can force companies into years of costly litigation.

Discussions at the STJ precede hearings at Brazil’s highest court, the STF, which in November delayed a ruling on the constitutionality of the case. The aspects the STJ will debate on Wednesday will not be addressed by the STF, which will later assess the constitutional issues of the case.

“There is no consolidated legal jurisprudence in any of these aspects, which raises uncertainty about the potential outcome,” Credit Suisse Securities analyst Marcelo Telles wrote in a recent client note.

More than two-thirds of the losses potentially faced by banks relate to two failed economic stabilization plans during Fernando Collor de Mello’s scandal-plagued 1990-1992 presidency. Other lawsuits stem from the so-called Bresser and Verão plans during José Sarney’s 1985-1989 administration, which also failed to tame runaway inflation.

The failed policies pushed Brazil further into an economic tailspin, until the creation of a new currency, the real, in 1994 finally brought stability.

A final ruling on the cases may not come for weeks. The uncertainty has caused unease in the financial sector and weighed on bank shares. Since November, when the STF delayed the case, an index of financial shares fell 14 percent.

“Banks will have to pay an amount in excess of the provisions created for the cases so far,” said Carlos Gómez-López, an analyst with HSBC Securities USA Inc.



A ruling in favor of depositors would hurt President Dilma Rousseff’s efforts to revive Brazil’s sagging economy ahead of a re-election bid in October. State-run lenders would suffer the most and might be forced to turn to the government for fresh capital, according to Bank of America Merrill Lynch.

That could increase the likelihood of a downgrade to Brazil’s credit rating, analysts said.

Banks’ capital positions could be eroded too. A reduction in the supply of credit of about 1 trillion reais is the worst-case scenario, the central bank said last year. Banks and the government are hoping the STJ will limit potential losses by shortening the time period for which penalty interest must be paid.

Depositors and consumer-advocacy groups want the STF to resume hearings quickly. Justices at the STF, where analysts believe depositors have a bigger chance to win, asked in November for more time to discuss the matter.

State-run Caixa Econômica Federal is the most exposed to a negative ruling, according to JPMorgan Securities, with potential losses reaching 99 percent of equity. Banco do Brasil SA, also controlled by the federal government and the nation’s biggest bank by assets, could see losses equivalent to 29 percent of equity.

“Even a moderate impairment to book value could trigger concerns that the federal government will need to capitalize Caixa at a time when it has limited fiscal flexibility,” JPMorgan analyst Domingos Falavina said in a research note.

Private-sector banks Itaú Unibanco Holding SA and Banco Bradesco SA face potential losses of up to 15 percent of equity. The loss for Banco Santander Brasil SA could be 9 percent of equity, JPMorgan said. HSBC Holdings Plc estimates it could lose up to $600 million in the case.

Brazil’s central bank may also have to help private-sector lenders remain well capitalized, industry sources told Reuters. One of those sources expects banks to seek compensation from the government “since they followed orders from policymakers at the time.”