The Macroeconomics of Bank Interest Spreads: Evidence from Brazil

Bank interest spreads, defined as the difference between lending and deposit rates, average about 30 percentage points in Brazil. This figure is ten times larger than the average in industrial countries and three times larger than the Latin American average. This paper analyzes the causes and macroeconomic consequences of these extraordinarily high spreads. Regarding the causes, I argue that the high spreads can largely be accounted for by a credit program that requires banks to allocate a significant portion of their loans to selected high-risk, high-cost borrowers at below-market interest rates. Banks offset their losses in the selected market by charging a disproportionately higher spread in the non-selected market. I construct a general equilibrium model tailored to evaluate the positive and normative consequences of this policy on the Brazilian economy. I find that the pure cross-subsidy between bank borrowers accounts for about a half of the spread levels. I also find that eliminating this policy distortion would raise GDP by 8 percent and almost double the bank credit in the long-run