The purpose of this paper is to shed light on the dimensions of inefficiencies and the lack of competition in the banking system in Brazil with the ultimate goal of informing policy discussions. The paper focuses on estimating from in an international perspective, the micro and macro-drivers of spreads in Brazil. The paper presents a novel analysis of spreads in Brazil in an international context by comparing a large number of countries in terms of not only their net interest margin but, more importantly, in terms of the main drivers of spreads as a path towards a more nuanced measure of risk.

The paper is structured as follows: Section 2 discusses issues related to measurements and international comparisons of spreads focusing on Brazil and presents a review of the literature on the determinants of spreads in an international context. Section 3 outlines the methodological framework we used to estimate the main groups of determinants of spreads in Brazil and across 197 countries and areas in the world. Section 4 presents and analyzes the data. Section 5 discusses the baseline results from our estimations for Brazil from a country-specific perspective. Brazil is compared to other countries across different dimensions, such as the degree of economic and financial market development. We compare Brazil to the other BRIC countries, to the US and to its geographical region. Section 6 presents a battery of robustness analyses that reveals caveats but also the strength of our baseline results. Section 7 concludes and discusses policy implications.

# **2. Measurements and Determinants of Spreads in Brazil and Internationally**

## **_Measurement Issues and International Comparisons of Spreads_**

Empirical measures of bank spreads attempt to capture the cost of financial intermediation such as the difference between what banks charge borrowers and what they pay depositors. The theoretical concept of the cost of financial intermediation, however, has no unique empirical counterpart. The reason is that banks do not charge only one loan rate or pay a single deposit rate. Indeed, on any particular day, every bank charges and offers a multitude of rates depending on classes of customers and types of products the bank supplies. Moreover, it is not an uncommon practice for banks to increase their revenues from loans by charging fees and commissions. These fees and commissions, while not included as interest charged, effectively increase the cost faced by bank borrowers (Brock and Suarez, 2000).

An additional problem in measuring bank spread is that, by including all interest earning assets and liabilities, net interest margins may deviate significantly from the marginal spread that reflects a bank’s marginal costs and revenues (Brock and Suarez, 2000). This is particularly true in countries where banks hold non-interest bearing assets as reserves and a significant amount of low-yielding bonds (largely government bonds in Latin American countries). The concept is also subject to important misrepresentation when banks experiencing serious difficulties are allowed to re-capitalize themselves by issuing bonds to be bought by the government (or the central bank) at below market prices.

We use a homogenous measure using the same methodology for all countries in our dataset to ensure cross country comparisons. We use the net interest margin (NIM) because we believe is an appropriate measure of the bank spread since it is a homogeneous measure of banks' profitability measured using international accounting standards collected by BankScope. Other measures of the bank spread provided by the International Monetary Fund’s, International Financial Statistics (IMF, IFS) database may not be appropriate because reported interest rates are not homogeneous between countries. Using 3