Brazil’s 1964 PAEG Reforms, the Halles and Comind Collapses, and the BANESPA Deficit Loop

On December 31, 1964, nine months after Brazil’s military coup, President Humberto Castello Branco signed Law No. 4,595—universally known to Brazilian economists as the constitution of the national financial system. Drafted by Planning Minister Roberto de Oliveira Campos and Finance Minister Octávio Gouveia de Bulhões under the Government Economic Action Program (Programa de Ação Econômica do Governo, or PAEG), the statute dismantled Brazil’s fragmented post-war monetary regime, established the National Monetary Council (CMN), and created the Central Bank of Brazil (Banco Central do Brasil, BCB). Together with Law No. 4,357 of July 16, 1964, which introduced statutory monetary correction (correção monetária) and inflation-indexed Treasury bonds (Obrigações Reajustáveis do Tesouro Nacional, or ORTNs), the PAEG reforms enabled Brazilian capital markets to function amidst chronic double- and triple-digit inflation. ^[1]

Yet the 1964 architecture contained two fatal structural flaws that haunted Brazilian banking for the next three decades. First, the retention of a dual monetary authority—through the shared clearing account (conta movimento) with the commercial state giant Banco do Brasil and the diversion of tax revenues into a discretionary “Monetary Reserve” (Reserva Monetária)—turned the Central Bank into an off-budget bailout fund whenever private financial conglomerates such as Banco Halles (1974) or Banco Comind, Auxiliar, and Maisonnave (1985) collapsed. Second, Brazil’s more than 25 state-government commercial banks, led by São Paulo’s BANESPA and Rio de Janeiro’s BANERJ, operated as quasi-central banks that printed money to finance regional fiscal deficits until the 1990s PROER and PROES restructurings finally closed the loop. ^[2]

The 1964 PAEG Blueprint: Law 4,357 (ORTN) and Law 4,595 (BCB)#

Before 1964, Brazil lacked an independent central bank. Monetary authority was split between the Superintendency of Money and Credit (SUMOC, created in 1945 as a normative council without a balance sheet) and the federal commercial bank, Banco do Brasil, which held bank reserves, operated the rediscount window, and financed Treasury deficits while simultaneously competing for private commercial deposits. Meanwhile, a colonial-era usury ceiling capping nominal interest rates at 12 percent per year—coupled with a ban on gold or foreign-currency indexation clauses—paralyzed long-term credit and destroyed the market for public debt as annual inflation surged past 80 percent in 1963–1964. ^[3]

Appointed in April 1964 to execute the PAEG stabilization program, Octávio Gouveia de Bulhões and Roberto Campos engineered a two-stage institutional revolution: ^[4]

• Monetary Correction and the ORTN (Law No. 4,357 of July 16, 1964): To resurrect voluntary domestic bond markets and stop taxpayers from profiting by delaying tax payments during high inflation, Law 4,357 legalized statutory inflation indexation. It created the Readjustable National Treasury Bonds (Obrigações Reajustáveis do Tesouro Nacional, ORTN), whose principal value was updated monthly or quarterly according to wholesale price indices. Soon extended by Law No. 4,380 (August 1964) to mortgage contracts and savings passbooks under the new National Housing Bank (BNH), the ORTN unit became the universal unit of account for Brazilian financial contracts, allowing banks to collect savings and extend credit despite persistent inflation.
• Creation of the CMN and Banco Central do Brasil (Law No. 4,595 of December 31, 1964): Enacted on the final day of 1964 (and entering into operation on March 31, 1965), Law 4,595 replaced SUMOC with the National Monetary Council (CMN) and created the Banco Central da República do Brasil (renamed Banco Central do Brasil in 1967). Complemented by the Capital Markets Law (Law No. 4,728 of July 1965), the reform segmented Brazilian finance along American Glass-Steagall lines into commercial banks, private investment banks, consumer finance companies (financeiras), and savings-and-loan associations.

Despite Campos and Bulhões’s push for central-bank orthodoxy, political resistance from Banco do Brasil’s powerful agrarian caucus preserved the conta movimento—an automatic zero-interest overdraft account at the BCB that allowed Banco do Brasil to expand credit without limit until the account was finally frozen in 1986. ^[5]

The 1974 Banco Halles Intervention and the “Monetary Reserve” Bailout Machine#

During the “Brazilian Economic Miracle” (1968–1973), Finance Minister Antônio Delfim Netto encouraged rapid bank mergers that transformed segmented institutions into sprawling financial conglomerates centered on a flagship commercial and investment bank. These conglomerates funded long-term corporate and real-estate ventures through short-term overnight repurchase agreements (cartas de recompra) backed by ORTNs and Treasury bills, and through foreign Eurodollar loans channeled under Central Bank Resolution 63. ^[6]

When the 1973 OPEC oil shock prompted incoming Finance Minister Mário Henrique Simonsen to tighten liquidity in early 1974, overextended conglomerates faced immediate funding runs. The most dramatic casualty was the Rio- and São Paulo-based Grupo Halles, Brazil’s ninth-largest financial group, which had masked heavy operating losses through inter-company loans and unrecorded overnight repurchase commitments. On April 16, 1974, in its 226th session, the National Monetary Council ordered the Central Bank of Brazil to decree a direct intervention in Banco Halles S.A. and its eleven affiliated investment, brokerage, and finance subsidiaries, implemented under Law No. 6,024 (which had been hastily enacted a month earlier on March 13, 1974 to govern bank interventions and extrajudicial liquidations). ^[7]

Fearful that losses on Halles’s money-market IOUs would trigger a systemic run on the domestic open market and scare off foreign Eurodollar lenders, the BCB guaranteed 100 percent of Halles’s depositors and overnight investors, engineering the absorption of its commercial banking network by the state-owned Banco do Estado da Guanabara (BEG). To finance the Halles rescue and subsequent bailouts of groups such as Ipiranga and União Comercial without legislative appropriation, the CMN diverted revenues from the Financial Operations Tax (IOF) into the BCB’s off-budget “Monetary Reserve”—establishing a dangerous moral hazard in which bank owners privatized boom-time profits while the Central Bank socialized insolvency losses through high-powered money creation. ^[8]

November 19, 1985: The Extrajudicial Liquidation of Comind, Auxiliar, and Maisonnave#

Those structural vulnerabilities exploded a decade later during the Latin American debt crisis and the transition to civilian rule in 1985. Cut off from international interbank credit after 1982 and squeezed by soaring domestic inflation exceeding 200 percent per year, several major private conglomerates concealed deep insolvency behind fictitious intra-group loans and high-interest retail certificates of deposit. Early in 1985, the collapse of the southern conglomerate Banco Sulbrasileiro forced the new civilian government of President José Sarney to nationalize the failed bank as Banco Meridional at a heavy public cost.

Determined to halt full-scale nationalization of bankrupt private lenders, Finance Minister Dilson Funaro and Central Bank President Fernão Carlos Botelho Bracher convened an emergency session of the National Monetary Council on November 19, 1985 (Ata 454) and ordered the simultaneous extrajudicial liquidation of three major financial conglomerates:

• Banco do Comércio e Indústria de São Paulo S.A. (Comind), then one of the ten largest private commercial banks in Brazil, with extensive foreign branches;
• Banco Auxiliar S.A., a prominent São Paulo commercial and investment banking group controlled by the Bonfiglioli family’s Corporação Bonfiglioli; and
• Banco Maisonnave S.A., a Rio Grande do Sul financial conglomerate.

Central Bank examiners uncovered massive hidden capital deficits (passivos a descoberto) across the three groups totaling trillions of cruzeiros, alongside roughly US$450 million to US$600 million in unbacked external interbank liabilities held by Comind’s and Auxiliar’s overseas branches in New York and Grand Cayman. While the BCB wiped out the controlling shareholders and froze insider assets under Law 6,024, it again injected vast liquidity to protect retail sight depositors and negotiated partial repayments with foreign creditor banks to prevent cross-default clauses from derailing Brazil’s sovereign debt rescheduling.

The State-Bank (BANESPA and BANERJ) Money-Creation Loop#

Even more destructive to monetary stability than private bank failures was the fiscal loop operated by Brazil’s 25-plus state-owned commercial banks, led by the flagship Banco do Estado de São Paulo (BANESPA) and Rio de Janeiro’s Banco do Estado do Rio de Janeiro (BANERJ). Throughout the 1970s and 1980s, powerful state governors treated their state commercial banks as captive regional central banks: ahead of every gubernatorial and congressional election (notably in 1982, 1986, and 1990), BANESPA and its peers extended billions of dollars in non-performing loans to their controlling state treasuries and state-owned utilities, or underwrote unsellable state treasury bonds.

Whenever these political loans left BANESPA or BANERJ unable to clear daily interbank checks or roll over overnight deposits, the state banks turned to the Central Bank of Brazil’s liquidity window. Because closing the largest clearing bank in São Paulo—Brazil’s industrial heartland—was politically and systemically unthinkable, the BCB repeatedly extended emergency liquidity lines or swapped unmarketable state bonds for federal securities, allowing state governors to export their fiscal deficits directly onto the balance sheet of the national monetary authority.

During the 1987–1993 hyperinflationary spiral, state and private banks alike masked their balance-sheet insolvency through inflationary “float” revenues—collecting zero-interest sight deposits from the public and investing the funds in overnight indexed government bonds paying real rates plus daily monetary correction. When the July 1994 Real Plan abruptly brought monthly inflation down from over 40 percent to single digits, bank float revenues vanished overnight. On December 30, 1994, the Central Bank placed both BANESPA and BANERJ under Special Temporary Administration (RAET). Over the next six years, President Fernando Henrique Cardoso and Central Bank President Gustavo Loyola deployed two landmark resolution frameworks—PROER (November 1995) to merge failing private banks such as Nacional and Econômico into healthy rivals, and PROES (August 1996) to refinance, liquidate, or privatize the state commercial banks, culminating in the sale of BANERJ to Banco Itaú in 1997 and the federal cleanup and privatization of BANESPA to Spain’s Banco Santander in November 2000.

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