SAO PAULO, Oct 2 (Reuters) - Moody's Investors Service lowered its rating outlook for Brazil's banks to "negative" from "stable" on Thursday as a sagging economy makes it increasingly difficult for lenders to extend credit, control loan defaults and boost profitability.
The lowered outlook, which in this case describes Moody's view of a sector, came as persistently high inflation, a cooling labor market and declining business confidence hamper both demand for credit and banking earnings, a team of Moody's analysts led by Ceres Lisboa said in a report.
Despite ample liquidity and smaller funding needs, Lisboa said low growth could compromise the ability of Brazil's banking system to generate profits and bolster capital. The report noted that robust capital should allow banks in Latin America's largest economy to absorb losses even in the event of financial stress, however.
Thursday decision by the ratings agency highlights the risks facing Brazil's next president, as four years of sluggish economic expansion and a dramatic slump in investor confidence threaten to impair a decade of economic and social gains.
According to Moody's, active state intervention in the economy is one of the factors hurting investment.
"The country's diverging fiscal and monetary policies and the upcoming election have fueled even more uncertainty among investors, which will weigh further on the banks' ability to generate capital," Lisboa said.
Brazilians will cast ballots in the country's presidential election on Sunday. Speculation last month that President Dilma Rousseff could lose to a more business-friendly candidate triggered a market rally, especially in banking stocks. But that rally has fizzled since Rousseff overtook rivals in recent polls.
Moody's published a note last year warning about the risks stemming from rapidly growing balance sheets at state-run lenders.
The country's banking system has "bifurcated," according to Moody's, with government banks pursuing aggressive growth while private-sector banks turn more prudent. Lisboa said state-run banks have only recently started to pull back on loan growth.
"Still, given the high proportion of riskier loans, their provisioning costs will be higher than for private lenders," Thursday's report said. (Reporting by Guillermo Parra-Bernal; Editing by Tom Brown)