BANKING SPREADS IN LATIN AMERICA

I. INTRODUCTION Financial intermediation in Latin America is low by international standards. Financial systems in Latin America are still largely bank based, but after a short period of strong credit growth sparked by financial liberalization in the early 1990s, bank lending has not yet recovered from the collapse following the banking crises of the mid-1990s, as shown by Singh et al. (2005). As a result, from Figure 1, it is clear that bank lending as a percentage of gross domestic product (GDP) is low compared to industrialized countries and other emerging markets. This lack of financial intermediation is seen as an important obstacle to growth: there is a considerable body of evidence indicating that financial intermediation is not only correlated with growth but also a causal factor in explaining economic performance (see, e.g., Levine 2004). The low levels of lending in Latin America appear related to the prevalence of high intermediation costs in the region. Intermediation spreads in Latin America are high compared to those in other banking markets. This is true when measuring spreads as either ex-ante bank spreads (the difference between weighted averages of lending rates and bank funding costs; Figure 2) or ex-post net interest margins (defined as the bank's total interest income minus total interest expense, divided by the sum of interest-bearing assets; Figure 3). The high levels of spreads are not a recent phenomenon and unlikely to be a result of the ongoing process of bank consolidation. As in other regions, in the 1990s, Latin America saw a trend toward bank consolidation and concentration. To a large extent, as depicted in Inter-American Development Bank (2004), consolidation was driven by financial crises and subsequent regulatory tightening. While this resulted in a marked reduction in the number of banks in most countries, it does not seem to have yielded a decline in competition intensity, partly because it was accompanied by a lowering of barriers of entry to foreign banks, which is shown in Gelos and Roldos (2004) and Inter-American Development Bank (2004). In fact, banking spreads have fallen somewhat over the past decade, although the pace of the reduction has been slow (Figure 4). (1) This paper takes a closer look at the determinants of bank interest margins in Latin America using bank- and country-level data from 85 countries, including 14 Latin American economies. We assess the role of bankand country-specific factors in determining banking spreads using microdata from more than 2,200 banks. Taking an international perspective allows us to delineate the key dimensions in which Latin America differs from other regions. The paper differs from existing studies in further dimensions apart from the Latin American-specific focus in a cross-country approach. Among other aspects, we make use of new or expanded data sets (including comprehensive information on reserve requirements and foreign ownership) and investigate the relationship between competition and bank spreads using behavioral measures of bank competition suggested by the new industrial organization literature. [FIGURE 1 OMITTED] [FIGURE 2 OMITTED] The results suggest that Latin America has higher interest rate levels, less efficient banks, and larger reserve requirements than other regions and that these factors have a significant impact on spreads. However, Latin American countries do not differ markedly from their peers in other aspects that are found important in determining the cost of financial intermediation, such as inflation, bank profit taxation, average bank size, or average equity as a percentage of total bank assets. II. THE DETERMINANTS OF SPREADS: LITERATURE REVIEW The extensive literature on bank behavior suggests that, at the country level, the following factors are likely to influence the cost of credit: * Creditor rights and the quality of the legal framework: Higher recovery rates and shorter times to repossess collateral in countries with better legal environments are expected to reduce bank spreads. …