High Lending Interest Rates in Brazil: cost or concentration?

Thiago Trafane Oliveira Santos ()

No 550, Working Papers Series from Central Bank of Brazil, Research Department

Abstract: Why are lending interest rates so high in Brazil? This paper seeks to answer this question through counterfactual exercises, which are simulated using a Cournot model. The proposed model is estimated for the nonearmarked market between March 2011 and May 2019. The estimates of the price elasticities of demand are always negative and statistically significant, implying the markup increases with concentration in my model. Using the estimated model, I performed counterfactual exercises, finding the higher lending rates in Brazil vis-à-vis other South American countries between 2012 and 2016 can be explained by (i) IOF tax, (ii) high level of the risk-free interest rate, (iii) higher probability of default, (iv) lower recovery rate, and (v) more concentrated financial system. This result is mainly driven by the cost components, as the changes in IOF tax, risk-free interest rate, recovery rate, and probability of default account for 89% of the optimal lending rate reduction in the counterfactual scenario. Or, in terms of optimal bank interest spread, costs explain 78% of the decrease. Therefore, concentration is only of second-order importance: the higher lending rates in Brazil are largely a story of higher banks' costs.

Date: 2021-05
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