By Marcela Ayres

BRASILIA (Reuters) -Brazilian banks' profitability improved in the first half of this year, led by digital banks, and net interest income and service revenues should continue to rise in the second half, the central bank said on Thursday.

In its Financial Stability Report, the central bank noted that the annual return on equity (ROE) for the country's banking system rose to 15.11% by June 30, up from 14.23% at the end of December 2023.

Digital banks stood out, with their ROE rising to 19.1% by the end of June - the highest among segments - from 11.45% at the end of December.

The group includes institutions such as Nubank, Banco Inter, and C6 Bank.

The central bank attributed the sharp increase to "positive effects of operational leverage through the monetization of customer bases by some institutions and lower pressure from provisioning expenses."

Between April 2020 and the end of last year, digital banks consistently reported single-digit or negative 12-month ROE.

Speaking at a press conference, the central bank's director of supervision, Ailton de Aquino, said digital banks have a "robust" credit model, attributing their lower provisioning levels compared with public and private banks to the sector's level of maturity.

He noted that the evolution of digital institutions in Brazil reflects the central bank's efforts to promote innovation and competition.

Following reports that Nubank, the country's largest digital bank with nearly 100 million clients, was considering relocating its domicile to Britain, Aquino said the central bank is "aware" of the initiative.

REGULATORY CHANGES

Ahead of a major regulatory change set to take effect in January, which will align the accounting of financial instruments with international standards, the central bank estimated institutions would need to increase provisions by around 38 billion reais ($6.5 billion) due to the changes, equivalent to 10% of current provisioning levels.

The new provisions will be accounted for as "capital counterparts," meaning the move will not impact institutions' results or their credit issuance, Aquino said.

He added that a smaller group of banks had expressed concerns about the upcoming impact but noted that there had been adequate time for the transition and that any issues would be addressed on a case-by-case basis by the central bank.

For the sector as a whole, the central bank said the cycle of risk materialization had weakened, easing the burden of provisioning expenses on overall results.