OREANDA-NEWS. We revised up Brazil's GDP growth expectations for 2017 and 2018 but do not expect banks to resume lending immediately and do not anticipate any real recovery in lending before 2017, says Fitch Ratings.

Banks cut back on new lending in both 2015 (minus 3.2%) and 1H16 (minus 6.8%) as they adopted a conservative approach in the face of recession, slumping consumer spending, weaker confidence and falling investment. We expect banks to continue this cautious approach to credit demand until they see clear signs that economic growth can be sustained. We expect GDP to contract by 3.3% in 2016 but we have slightly increased our growth forecasts to 1.2% in 2017 and 2.2% in 2018, respectively from 0.7% and 2%.

Investment recently showed its first quarterly increase since 3Q13 and we expect to see the first signs of new credit demand from corporates as they make efforts to fill their depleted inventories. But, in our view, banks will return timidly to corporate lending because many companies display weak financial metrics and the number of bankruptcy protection filings remain high. These increased 87% in 1H16 from 2015, forcing banks to restructure a record number of loans to comply with the terms of a growing number of judicial recovery proceedings.

Cash flow generation in the corporate sector is weak, making it difficult for companies to support the high cost of borrowing in Brazil. We estimate that the average interest rates charged on corporate lending reached an annual 20% in 1H16. Banks are keen to preserve their margins to compensate for heightened corporate credit risk. In addition, corporate balance sheets are often highly encumbered, making it difficult for banks to ask for additional collateral to provide added security against their loans.

Our expectation is that the central bank will start to ease interest rates this year, provided there are signs of disinflation. Lower rates would help the flow of credit to the corporate sector as even Brazil's prime companies are struggling to take on more debt at current rates. But even if the cost of lending falls, we are not convinced that banks will relax their underwriting standards, which were considerably tightened at the outset of the recession. Based on our discussions with management at rated banks, we believe lenders are as yet unwilling to adjust their lending standards until signs of an economic upturn become apparent.

Demand for consumer lending is likely to remain weak at least until unemployment levels, which reached nearly 12% in August, start to come down.

Bank performance targets will be squeezed in the closing months of 2016 - the system's annual ROAA fell to 0.96% (as of June 2016) from a ROAA of 1.28% at end-2015. Impairment charges, especially at the second-tier banks and those owned the federal government, are likely to remain high.