Brazilian retail banking and the 2008 financial crisis: Were the government-controlled banks that important?

https://doi.org/10.1016/j.jbankfin.2012.03.009Get rights and content

Abstract

We revisit the interest rate pass-through effect using weekly retail banking data from May 2006 to March 2010. Our choice of data avoids caveats of previous studies concerning excessive data aggregation and the estimation of how fast changes in benchmark interest rates impact those charged on short-term loans in Brazil. Our analysis focuses on four large retail banks – two of them privately owned and run, two of them government-controlled – before and after September 2008. They account for 60% of the total credit supplied by retail banks. Results indicate that government control over two of the largest banks, supposedly an asset for crisis management, may have had higher welfare costs than assumed. We find no evidence of asymmetry in adjustments of retail rates charged by private and government-controlled banks.

Introduction

This paper aims to contribute to research on interest rate pass-through and monetary policy transmission in oligopolistic banking markets. These are critical issues from academic and policy standpoints, as revealed by a rapidly growing, rich, international literature.1 Along with the analysis of a variety of relevant aspects, contributions typically apply econometric techniques to estimate how fast and thorough the adjustments of interest rates are to changes in base rates or money market rates, which are directly influenced by monetary authorities.

Espinosa-Vega and Rebucci (2003) applied a standard Error Correction Model to consider whether interest rate pass-through in Chile’s recent experience was atypical compared to 10 other countries, including the United States. Indeed, the adjustment in the Chilean banking sector was incomplete – like in other countries – but generally faster than those in the rest of their sample. Also interesting was the fact that the adjustment process was affected by institutional changes in the exchange rate regime and Chile’s monetary policy targeting.

Hofmann and Mizen (2004) investigated 17 years of monthly data for rates on 13 deposit and mortgage products offered by UK financial institutions, considering potential non-linearity in adjustment of retail rates to base rates, due to menu costs. In their empirical exercise, the speed of adjustment responded nonlinearly to the expected size of the gap between the base and retail rates in the near future. In other words, the perceived (expected) “aggressiveness” in base rate management was a significant factor explaining the speed of pass-through effects.

Euro-area cross-country comparisons conducted by Sørensen and Werner (2006) raised empirical evidence of high-degree heterogeneity in pass-through of base rates to bank interest rates. Among other cyclical and structural factors, they found different degrees of competition in national banking sectors to be the most significant determinants of pass-through speed.

The focus of the present investigation is to address such issues for the Brazilian banking sector, a country with three well-known and somewhat unique characteristics:

  • (i)

    Persistently, extraordinarily high interest rates on short term loans – in comparison to the ones observed in other emerging economies.

  • (ii)

    Very high (and growing) market concentration, revealed by the participation rates of the four largest banks in total volume of credit operations and total assets.

  • (iii)

    Significant participation of government-controlled public banks (GCBs, hereafter) in both volume of credit and assets.

A number of conjectural explanations for persistently high interest rates in Brazil have been statistically tested and not rejected; examples include extremely high reserve requirements to commercial banks (above 50% for checking accounts), heavy taxation on credit operations, high delinquency rates, political or institutional uncertainty, and lack of competition in the banking sector (World Bank, 2006).

The last conjecture listed above – lack of competition – was somewhat discredited, although not entirely dismissed, in studies published by policy researchers associated with the Brazilian Central Bank.2 Tonooka and Koyama (2003) searched for but found no relationship between interest rates on loans and market concentration in the Brazilian banking sector. Alencar (2003) estimated the speed of pass-through effects from changes in benchmark interest rates and compared them to those observed in retail banking. Full response of monthly-average retail rates to changes in the opportunity cost of money, occurring over less than 12 months, was pointed out as evidence of a significant degree of competition, driving banks to operate efficiently.

During the financial crisis, the Brazilian government praised GCBs several times for playing an important role in stabilizing the economy and for helping achieve a faster pass-through from benchmark to retail rates. Indeed, Bernanke and Gertler (1995) found that the existence of a market imperfection increases the effectiveness of monetary policy. Recently, Coelho et al. (2010) found that the pass-through is higher for larger banks using a sample from June 2000 to December 2006.

In this paper, we revisit the pass-through effect in the Brazilian banking industry using data made available on a daily basis by the Brazilian Central Bank – compiled and assembled into a time series for this specific purpose. This high-frequency data set on rates charged by individual banks to businesses is informative about the pass-through effect in an oligopolistic credit market because the speed of adjustment can be estimated (and compared) for each of the four largest institutions – two of them privately owned and run, two GCBs. Over time, faster adjustments to changes in benchmark interest rates would be evidence of GCBs’ role in strengthening the impact of monetary policy, under typical or exceptional circumstances.

Our main results indicate a larger pass-through after the financial crisis than before September 2008, but no asymmetric response from private banks and GCBs. GCBs were actually not responsive to changes in the benchmark interest rate before the financial crisis. The changing behavior of the GCBs after the financial crisis3 should be interpreted with caution, however, as there was a substantial increase in market concentration over the considered period.4

The remainder of the paper is structured as follows: Section 2 details our choice of data. Section 3 describes the econometric approach to calculate the pass-through. Section 4 presents our main results. Finally, Section 5 summarizes and concludes the paper.

Section snippets

Previous and current choice of data

Previous studies of the pass-through effect in Brazil were conducted on overall averages of interest rates in the banking sector, including multiple banks and different credit instruments – although broken into two debtor categories: personal/individual loans and businesses ones.

Empirical application

We estimate the pass-through from monetary policy to retail rates using an Autoregressive Distributed Lag (ARDL) model as proposed by Wickens and Breusch (1988):it=α0+k=1mβkit-k+p=0nδprt-pwhere “i” is the retail interest rate and “r” is the Central Bank controlled interest rate (“Selic”). δ0 is the short-run effect – within the week after the Central Bank changes the “Selic”. One expects to find 0 < δ0  1. δ0 < 1 indicates sluggish adjustment, also known as lending rate stickiness. δ0 = 1 represents

Results

Results from the estimation of Eq. (1) and the F-statistic (Eq. (4)) are presented in Table 1, Table 2, Table 3, Table 4. We summarize and discuss the most important findings below.

Table 1 indicates very different behaviors of private banks and GCBs in the complete sample. Private banks react to changes in the monetary policy interest rate both in the short and long run – as indicated by the magnitude and significance of the coefficients. Almost all pass-through coefficients calculated for

Conclusions

We find clear evidence of a pass-through from the monetary policy interest rate to retail rates after the financial crisis for all banks in our sample. The estimated long-run effect is particularly large for Banco do Brasil, as coefficients are significant and greater than 1 for all types of loans after the crisis. However, we find no evidence of asymmetry in adjustments of retail rates charged by privately owned and government-controlled banks after the crisis.

Considering results obtained from

Acknowledgments

We are grateful to an anonymous referee, Ike Mathur (editor), Luiz Kehrle, Horst Möller and seminar participants at the UCR Latin American Studies Conference 2010, Riverside, for their comments and suggestions on the earlier versions of this paper. We also thank Ana Champloni, Felipe Rocha, and Filipe Braga for research assistance and Sean Higgins for proofreading the paper.

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