policy recommendations<sup>3</sup> . The studies do not take account of the aforementioned anecdotal evidence of stronger competition among banks in the market for loans to large corporations compared to the market for loans to consumers and small firms<sup>4</sup> . Understanding the characteristics and drivers of performance in different market segments is critical for the formulation of public policy to make access to credit more affordable while keeping the system stable, but there has not been – to our knowledge – a study on this issue in Brazil.

4. **The objective of this paper is to analyze the industry structure of banking services in Brazil, assessing competition and performance at a disaggregated level**<sup>**5**</sup> . In particular, the paper focuses on the characteristics, financial performance and drivers of the two most important banking market segments: Corporate and Retail. Each of the two segments is defined at a high level due to data availability constraints, but they align fairly closely with actual bank practice since banks typically have separate business lines catering to the needs (loans, deposits, payments etc.) of these different markets.

5. **In order to pursue this task, the paper adopts a so-called ‘practitioner approach’** . In particular, the performance of different market segments is estimated directly by disaggregating all the revenues, costs, and risks of the banking system into different lines of business in order to obtain key profitability ratios<sup>6</sup> . While high profitability is insufficient _per se_ to infer the level of competition by market segment, it is typically positively correlated to market power, and it represents one of the most relevant indicators used by banking industry practitioners and analysts. This approach is complemented by a review of the existing financial sector literature and by interviews with senior management of eight Brazilian banks of different size and ownership structures, which serve as a consistency check on the study’s findings and are used to identify the main performance drivers in each market segment<sup>7</sup> .

6. **The paper is organized into three main sections, complemented by appendices that describe methodological aspects in more detail.** Section 2 (as well as Appendices I and II) presents the methodology and results, including sensitivity analysis. Section 3 identifies and discusses the characteristics and main drivers of revenues, costs and risks by each market segment, while Section 4 concludes and presents policy implications.

> 3 Belaisch (2003) also distinguishes between state-owned, small/medium size and foreign-owned banks, and finds that the first two types behave oligopolistically while only foreign banks behave competitively. 4 Individuals face short maturities and interest rates from around 25-30 percent p.a. (per annum) on car loans, to 45-50 percent p.a. on personal loans and up to 140 percent p.a. on overdrafts.

> 5 The paper is based on a comprehensive study by the World Bank (June 2007) on this topic, but it has been updated to reflect 2006 figures and recent market developments.

> 6 The approach results in the creation of stand-alone notional financial statements and related financial ratios (e.g. pre-tax return on capital and assets, cost-to-income ratio etc.) by business line as of December 2007, which can then be compared to each other and to the ones for the entire banking system.

> 7 Interviews were conducted both with senior bank management to get an overall perspective of the system, as well as with business line managers to obtain more detailed information. The interviews covered 2 public banks, 2 large domestic private banks, 1 smaller domestic private bank, and 3 foreign banks.

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