Since the IFS spreads are not comparable across countries (due to differences in maturities, type of interest such as fixed or variable, the credit worthiness of the creditor, etc.) we use the NIM because it covers a wide range of borrowers and several types of interest rates. Moreover, we find that there is very little correlation between the interest rate spreads reported in the IFS database and the NIM across countries (Figure 1a). As expected, we find little correlation between Brazil's NIM and IFS spreads (Figure 1b). Brazil ranks at the top of the world in terms of the IFS spreads but not in terms of the NIM. Over time both the IFS and the NIM spreads have varied considerably in Brazil, from 33 to 58 percent for the IFS spread and from 8 to 15 percent for the NIM.

In order to make sure that our results are comparable across countries we need to control for institutional and regulatory features. A method to account for such heterogeneous institutional and regulatory features requires the adjustment of the net interest margin (NIM) for such factors. The resulting measure is the pure spread which is comparable across countries. The key reference for the method of deriving the pure spread is Saunders and Schumacher (2000). The same method is used in cross-country studies in Brock and Rojas Suarez (2000) and Maudos and de Guevara (2004).

# **_Determinants of Spreads in Brazil and Internationally: A Review of the Literature_**

The literature on the determinants of spreads, which often include cross-country studies, mainly focuses on the spreads’ determinants. Saunders and Schumacher (2000) for example find that the regulatory components in the form of interest-rate restrictions on deposits, reserve requirements and capital-to-asset ratios have a significant impact on banks NIMs. They also find that the more segmented or restricted the banking system is, both geographically and by activity, the stronger the monopoly of power existing banks hold appears to be, and the higher their spreads. They find that macro interest-rate volatility has a significant impact on bank NIMs, suggesting that macro policies consistent with reduced interest-rate volatility could have a positive effect in reducing bank margins.

In a paper that adopts a similar methodology, Brock and Suarez (2000) find that both high operating costs as well as high levels of non-performing loans increase spreads, although the size of these effects differ across the countries. In addition, reserve requirements in a number of countries still act as a tax on banks translating into a higher spread. They also note that beyond bank specific variables, uncertainty in the macroeconomic environment facing banks appears to increase interest spreads.

Demirguc-Kunt and Huizinga (1999) note that recent research, as surveyed by Levine (1997), shows that the efficacy of financial intermediation can affect economic growth. Crucially, financial intermediation affects the net return of savings and the gross return of investment. The spread between these two returns mirror bank interest margins, in addition to transaction costs and taxes borne directly by savers and investors. Thus bank interest spreads could be interpreted as an indicator of the efficiency of the banking system.

Demirguc-Kunt and Huizinga (1999) investigate how bank interest spreads are affected by taxation, the structure of the financial system, and financial regulations, such as deposit insurance. A comprehensive review of the determinants of interest spreads are offered by Hanson and Rocha (1986), who summarize the role that implicit and explicit taxes play in raising spreads and discuss some of the determinants of bank costs and profits, such as inflation, scale economies, and market structure.

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