25. **There are several drivers on the revenues side that support high interest income and fees** . The small size of individual clients does not typically allow them to negotiate rates, while independent alternative non-bank providers of such services are relatively few<sup>24</sup> . Regulation is important since it has tended to discourage client switching due to the (recently-abolished) penalizing financial transactions tax CPMF ( _Contribucao Provisoria sobre Movimentacao Financiera_ )<sup>25</sup> , the lack of sufficient positive information sharing on borrowers ( _cadastro positivo_ )<sup>26</sup> , and the structure of payroll account relationships<sup>27</sup> . Other potentially important switching barriers include the convenience factor and related need for a branch network by individuals, product bundling by banks (e.g., linking of deposit accounts to cheaper payment and loan services), as well as inefficiencies in the retail payment systems infrastructure. An example of the latter issue is the low level of interoperability between Automated Teller Machine (ATM) and Point of Sale (POS) networks of banks<sup>28</sup> . As a result, bank customers cannot generally access other banks’ networks, creating an infrastructure barrier to efficient competition. Other factors, such as branding, service quality and perceptions of solvency also act as barriers to entry for potential competitors by leading to less price-sensitive behavior by consumers. Some of these factors are common to other countries, as evidenced by international consumer surveys indicating that proximity, perceptions of solvency, and brand image tend to be ranked above pricing as determinants of the primary banking relationship.

26. **Although funding costs are low, operating costs in the Retail market segment are very high** . Regulation – in particular, the presence of savings and special deposit accounts – has contributed to low-cost funding. However, high reserve requirements tend to offset this advantage. On the operational side, in spite of economies of scale stemming from Brazilian banks’ success at standardizing and automating important features of the delivery system, operational costs remain very high. These include high fixed costs that are needed to set up the branch network and ICT infrastructure, as well as high variable costs that are needed to run it, which stem from high-volume, small value transactions and from an inefficient retail payments mix. In particular, the infrastructure for clearing transactions among banks is fragmented, which reduces economies of scale. The predominant use of cash and checks as payment instruments also implies higher costs and

> 24 Although there exist several credit providers for consumer durables (e.g. appliance stores), they tend to be associated with – and financed by – the banks themselves.

> 25 In fact, CPMF is not charged if there is an account transfer of the same type and with the same names, but according to bank interviews it dissuades most retail customers from performing any financial movements. See Ebrill, Summers and Coelho (2000) for a discussion of such taxes.

26 The lack of positive information limits the predictive ability of collected data and prevents consumers who honor their obligations to benefit from the ‘reputation collateral’ that they have built.

27 The practice until recently in Brazil has been that payroll accounts lock-in relationships with banks. On the one hand, banks obtain important information on the customer while, on the other hand, customers for convenience purposes (given search costs and lack of ATM interoperability across banks) tend to stay with the same bank. The potential payoffs from this “captive market” seemed to be so high that, in fact, banks paid considerable amounts to corporations and state/local governments to obtain those relationships. The situation is expected to change going forward, since the Brazilian authorities introduced regulations in 2006 to allow wage and credit account portability across banks – see OECD (October 2006) for a description. 28 See Western Hemisphere Payments and Securities Clearance and Settlement Forum (2004), Banco Central do Brasil (May 2005), and Cirasino et al. (forthcoming) for more details.

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