have the obligation to either lend another 25 percent for rural projects (earning a fixed rate of 8.75 percent) or leave those funds with Bacen earning no interest (some banks actually prefer this option). This means that only 12 percent of demand deposits collected by business lines are freely available to be used for lending purposes<sup>44</sup> .

RR are estimated by type of deposit and then allocated to business lines based on their respective deposit share. RR that are placed with Bacen appear as interbank transactions in the banking system’s balance sheet, so business lines that have such RR actually book them as such on their stand-alone balance sheets. All remaining interbank transactions (i.e. those that are not RR with Bacen) are assumed to be placements with other banks and are therefore allocated to Treasury.

Assumptions also need to be made about the remuneration of RR in order to estimate the income from such transactions (shown as interest revenue from required deposits in the banking system’s financial statements); the average Selic rate for 2007 is assumed to be 12 percent, while the average yield on savings accounts is assumed to be 7.5 percent. This income is allocated across business lines based on their respective type and volume of RR.

It is worth noting that 15 percent of time deposits must be held as RR in the form of securities investments; these investments are also allocated across business lines, while the residual volume is assigned to Treasury. No explicit assumption about the yield of these securities was made, so they effectively earn the average yield of all securities on the banking system’s balance sheet, which is implicitly calculated by dividing the relevant interest income by the average volume of these investments in 2007.

As a result, the RR of the Retail business line account for 63 percent of total, the Corporate business line accounts for 33 percent, and Government has a small share.

# **Allocation of Loans**

Bacen’s monthly report on financial system credit operations is used to allocate different types of loans (earmarked vs. non-earmarked, individuals vs. corporations, etc.) by business line. The report includes a higher credit figure than that reported by the banking system (BRL 1.1 trillion vs. BRL 935 billion as of end-2007) because the former is more comprehensive and includes non-bank sources of lending (e.g., credit unions, lending by development agencies etc.). These loans are selectively excluded from the analysis in order to arrive at the same gross credit figure as for the banking system, which needs to be allocated across business lines. Bacen’s report also includes the total volume of public sector credits (BRL 18.8 billion).

Given that the Retail business line includes small firms, dividing up reported lending figures between individuals and firms is insufficient for the allocation mechanism. An additional assumption that was made, based on bank interviews and 20-F reports on the distribution of loans by client size, is that 15 percent of all corporate loans are given to

> 44 There are additional complications for demand deposits that are not treated in this exercise, e.g. banks have the obligation of lending an additional 2 percent of their demand deposits to microcredit.

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