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International Review of Economics and Finance 40 (2015) 2939

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International Review of Economics and Finance


journal homepage: www.elsevier.com/locate/iref

Determinants of the banking spread in the Brazilian economy:


The role of micro and macroeconomic factors
Fernanda Dantas Almeida a, Jos Angelo Divino b,
a
Catholic University of Brasilia, Brazil
b
Catholic University of Braslia, Graduate Program of Economics, SGAN 916, Ofce A-118, Brasilia-DF 70.790-160, Brazil

a r t i c l e i n f o a b s t r a c t

Available online 11 February 2015 The objective of this paper is to identify the major determinants of the ex-post banking spread in
the Brazilian economy, considering the inuence of the macroeconomic environment, specic
JEL classication: characteristics of the nancial institutions, and elements from the banking sector. The empirical
C23 model is based on the pioneer work by Ho and Saunders (1981) and some of its extensions in
C58 the literature. The sample consists of a balanced panel, composed of 64 banks in the period be-
G21 tween the rst quarter of 2001 and the second quarter of 2012. The results of the static model sug-
Keywords: gest that administrative expenses, revenue from services and coverage index are important
Banking spread determinants of the ex-post spread. The macroeconomic environment showed positive effects
Financial sector arising from real GDP while the HerndahlHirschaman index indicated that spreads are higher
Panel data for a more concentrated banking system. The dynamic model revealed a moderate persistence
of the ex-post banking spread and a relevant role for the banks' market-share. The overall pure
spread indicates that banks consider the Brazilian economy a risky environment to operate.
2015 Published by Elsevier Inc.

1. Introduction

Credit concession denes an important role for nancial institutions in the economic growth of any country, providing nancial
resources to the various sectors of the economy and stimulating output growth. Levine (1997) for instance, showed that the efciency
of nancial intermediation can directly inuence economic growth. Financial intermediation affects the net return on savings and
gross investment and, consequently, the interest rates charged on loans. Thus, the level of interest spread can provide a clear signal
on how banks play their role in a given economy. Ho and Saunders (1981) argue that the volatility of the interest rate charged on
banking loans can congure a clear indicator of the country's macroeconomic stability. The more unstable is a given economy, the
greater is the volatility of its interest rates and, therefore, the higher might be the banking spreads.1
In Brazil, high levels of banking spreads collaborate with a combination of low credit to GDP ratio and high interest rates on loans.
Thus, the banking spreads have been the subject of several studies and the target of economic authorities' initiatives because of their
negative effects on both credit expansion and economic growth of the country.
After the Real Plan,2 which ended with a long period of high ination, the Brazilian banking sector lost the easy gains coming from
the inationary process and went through a profound reformulation. This process has reected in the banking spreads, which

The authors would like to thank the Guest Editors Michael McAleer and Shawkat Hammoudeh, the Editor Hamid Beladi, and an anonymous referee for the useful
comments and suggestions. Divino thanks CNPq from Brazil for nancial support. All remaining errors are the authors' sole responsibility.
Corresponding author. Tel.: +55 61 3448 7135; fax: +55 61 3447 4797.
E-mail addresses: fernanda.d.almeida@caixa.gov.br (F.D. Almeida), jangelo@ucb.br (J.A. Divino).
1
See, for instance, Kwapil and Scharler (2013) Blas and Russ (2013), Thumrongvit, Kim, and Pyun (2013), and Figlewski, Frydman, and Liang (2012) for addition
discussions on the banks' role in the economy.
2
The Real Plan is the most well succeed economic stabilization program in Brazil, which was launched in June 1994.

http://dx.doi.org/10.1016/j.iref.2015.02.003
1059-0560/ 2015 Published by Elsevier Inc.
30 F.D. Almeida, J.A. Divino / International Review of Economics and Finance 40 (2015) 2939

experienced a sharp decline since 1995 and then followed a stable path in the post 2000 period. In the same period, the credit supply
has shown a growing trend due mainly to the new scenario of economic stability and declining banking spreads. The adjustment of the
banking system to the new economic scenario was facilitated by the favorable macro-institutional environment. The good manage-
ment of the macroeconomic policy and, in particular, the rigorous administration of the public debt during the recent international
crises was able to preserve the nancial health of the Brazilian banks and contribute to maintain their high protability.
The Brazilian government launched, in 2012, a strategy to reduce interest rates charged on banking loans by using public banks in a
more aggressive market stance, aiming at increasing their credit portfolios. In this period, the banking spread reached one of its lowest
levels ever. This strategy resulted in increasing participation of the credit from public institutions in the total credit of the economy.
With falling interest rates of the public banks and the relative loss of participation in the total credit, private banks were required
to follow the market tendency, thereby contributing to the process of declining interest rates. This process, then, presents itself as a
challenge to nancial institutions that must adapt themselves to the new scenario of lower spreads.
The objective of this paper is to identify the major determinants of the ex-post banking spreads in the Brazilian economy.
Specically, the paper seeks to investigate the impact of macroeconomic variables on the spread, explore the effects of specic
characteristics of the nancial institutions, and investigate the effects of banking concentration on the interest rate differential. The
inedited database is represented by a balanced panel consisting of 64 banks with active commercial portfolios in the time interval
between the rst quarter of 2001 and second quarter of 2012. These data were obtained directly from balance sheets and income
statements of each institution, resulting in a broad and diverse set of micro nancial data.
The empirical model was based on Ho and Saunders (1981) and some of the extensions provided by Hancock (1985), McShane
and Sharpe (1985), Allen (1988), Zarruk (1989), Zarruk and Madura (1992), Angbazo (1997), and Wong (1997). The model is exible
enough to allow changes in variables without altering its fundamental characteristics. In addition to the conventional static estima-
tion, it is also estimated a dynamic version of the model. In the static regression, the main results suggest that microeconomic vari-
ables, such as administrative expenses, revenue from services, and coverage index, represent the major determinants of the ex-
post spread. Regarding the macroeconomic environment, the positive effect coming from the Gross Domestic Product (GDP) reveals
that the spreads are higher in the context economic stability. In turn, the HerndahlHirschaman (HHI) indicates that a more concen-
trated banking system offers support for banks to earn higher interest spreads.
The types of spread can be classied as ex-ante or ex-post, depending on the form of measurement. The rst one is measured from
the expectations of nancial institutions for granting credit, previously to the realization of its outcome. The second one is calculated
according to the effective amount of revenue coming from nancial intermediation and funding costs, which translates into the actual
outcome of the nancial intermediation activity. The ex-ante spread is more volatile because it reacts quickly to changes in the mac-
roeconomic scenario. However, the ex-post spread tends to be more stable, given that it represents the effective result from the nan-
cial intermediation activity.
Aronovich (1994) used a disaggregated sample by credit operation in the period from 1986 to 1992 to investigate the behavior of
the ex-ante spread in the Brazilian economy. The most relevant variables identied by the estimation procedure were ination and
economic shocks, both having positive effects on spread over operation of bill discounts. For working capital, although the estimates
were less efcient, one can mention ination rate, with a positive coefcient, and the level of economic activity, with a negative sign.
Koyama and Nakane (2002b) also evaluated the determinants of ex-ante spread by using a sample of monthly data for the period be-
tween 1996 and 2001. Their results suggest that the spread is signicantly affected by the basic interest rate, ination rate, level of
economic activity, administrative expenses, reserve requirement on deposits, indirect taxes, and a proxy for macroeconomic risk.
Afanasieff, Lhacer, and Nakane (2002), using the concept of ex-ante spread and monthly data from 1997 to 2000, found positive
effects arising from operating expenses and revenue from services. Among the macroeconomic variables considered in the analysis,
the basic interest rate and its volatility as well as the level of economic activity showed positive effects on spreads. In turn, ination
rate was negatively related to the spread. Bignotto and Rodrigues (2005) found positive relationships among ex-ante spread and ad-
ministrative expenses, revenue from services, size of the nancial institution, reserve requirements, total assets, credit risk, interest
rate risk, and basic interest rate in the period between 2001 and 2004. Among the variables negatively related to the ex-ante spread,
it is worth mentioning market share and wide consumer price ination (IPCA).
Guimares (2002) and Dantas, Medeiros, and Capelleto (2011) are among the few studies that investigate the determinants of the
ex-post spread in the Brazilian economy. The rst study used a sample from 1995 to 2001 and focused the analysis on the components
of the accounting decomposition and participation of foreign banks in the performance of the domestic institutions. The results sug-
gested that the spread earned by foreign institutions was statistically lower than the average spread of the national institutions. Ad-
ditionally, by segregating the sample between public and private domestic banks, it was inferred that public institutions earn lower
prot margins than the private counterparts. Dantas et al. (2011) sought to identify the determinants of the ex-post spread by focus-
ing on specic characteristics of the nancial institutions and microeconomic aspects of the market. The sample comprised data from
balance sheets published between the years of 2000 and 2009. The ex-post spread was signicantly affected by credit risk, degree of
banking concentration, level of economic activity and the relative size of each institution. With the exception of this last variable,
which displayed a negative coefcient, all others were positively related to the ex-post spread.
One can observe, therefore, that predominates in the empirical literature the use of ex-ante banking spread. This prevalence can be
explained by several reasons, including: (i) the annual banking reports are based on the ex-ante spread; (ii) the released time series by
the National Financial System refers to the metric of ex-ante spread; and (iii) the difculty of accessing information on the analytical
results of the nancial institutions, making it hard the computation of the ex-post spread. In addition to identify the major macro and
microeconomic determinants of the spread in both static and dynamic environments, this paper contributes to the literature by focus-
ing the analysis on the metric of ex-post banking spread.
F.D. Almeida, J.A. Divino / International Review of Economics and Finance 40 (2015) 2939 31

The paper is organized as follows. The second section presents the empirical model and discusses the econometric procedure. The
data set is explained in Section 3. The fourth section reports and analyzes the empirical results, including unit root tests and estimation
of the static and dynamic panel data models. Finally, the fth section is dedicated to the concluding remarks.

2. Empirical model

The theoretical model on which this paper is based on was proposed by Ho and Saunders (1981). This model has been empirically
tested and extended by several authors, including Hancock (1985), McShane and Sharpe (1985), Allen (1988), Zarruk (1989), Zarruk
and Madura (1992), Angbazo (1997), and Wong (1997). Ho and Saunders (1981) consider a risk-averse representative bank, which
acts as a player in the credit market, being responsible for attending the immediate demand of deposits and supply of loans. As a risk-
averse agent, the bank's objective is to maximize the expected utility of the wealth in the current period. It is assumed that all deposits
and loans are processed free of charge.
Banks receive deposit funds and loan requests not synchronously at random time intervals. The pure spread between loan and
deposit rates is a compensation for bank provision of liquidity. Ho and Saunders (1981) computed interest margins for nancial
intermediaries that offer homogeneous loans and deposits. The banking spread was found to be a function of the degree of managerial
risk aversion, average transactions size, competition within the bank's market, and the variability of interest rates.
To estimate the bank interest margin in equilibrium, called pure spread, Ho and Saunders (1981) considered that it would be nec-
essary to analyze both specic features of nancial institutions and market imperfections by using data on balance sheets of the banks.
These data provide information on several variables that might directly affect the actual interest margins. To proceed with the estima-
tion, they assumed that the interest margins encompasses a pure spread, due to uncertainty of the underlying transactions, as well as
implicit interest expenses for the opportunity cost of reserve requirement and credit risk. Several extensions have been proposed for
this model in the literature. Some of them are discussed below.
Hancock (1985) derived a variable prot function in order to include the effects of all prices on prots. Interest rates and other costs
of assets and liabilities are combined. This procedure includes both interest and noninterest items for each asset and liability and so
differs from Ho and Saunders (1981), who used noninterest costs to explain interest margins and aggregated all loans and deposits.
The model developed by McShane and Sharpe (1985) modies the integrated hedging and expected utility theory developed by
Ho and Saunders (1981) to explain the interest margins. The major difference lies in the assumption that uncertainty attaches to the
instantaneous short-term money market rate rather than to the deposit and loan rates. This assumption showed to be more reason-
able for the Australian banks, given the predominance of variable deposit and loan interest rates.
Allen (1988) extended the Ho and Saunders (1981) framework to consider the case of loan heterogeneity. In this scenario, pure
interest spreads are reduced when cross-elasticities of demand between bank products are considered.
Zarruk (1989) argued that the model developed by Ho and Saunders (1981) was intended for the analysis of the trading activities
of security dealers and so it fails to consider some relevant aspects of a bank's operation. A model of the banking rm under uncertain-
ty and risk aversion is proposed, resulting in some implications for the bank asset quality, capital regulation, and deposit insurance.
Later, Zarruk and Madura (1992) examined the relationships among capital regulation, deposit insurance, and the optimal bank
interest margin. They nd that changes in capital regulation or deposit insurance premiums have direct effects on the bank's interest
margins and increases in bank capital requirement or in deposit insurance premiums reduce the interest margins. Their results hold
under concave utility function or risk neutrality.
Wong (1997) considered the case of a simple rm theoretical model under multiple sources of uncertainty and risk aversion. In
this framework, the bank interest margin is positively related to the bank's market power, operating costs, degree of credit risk,
and degree of interest rate risk. The bank's equity capital is negatively related to the spread under reduced interest rate risk. Wong
claimed that these ndings offer alternative explanations for the bank spread behavior.
The theoretical extension proposed by Angbazo (1997) relies on the inclusion of credit risk and its interaction with the interest-
rate risk as another source of uncertainty. Angbazo tested the hypothesis that banks with riskier loans and greater exposure to interest
rate risk should practice higher loan and deposit rates in order to achieve higher interest margins. The relationship between these
risks reveals that the net interest margins practiced by commercial banks reect both of these risk premiums.
The empirical estimation was based on the net margins, represented by a function of the pure spread, and a vector of specic bank
characteristics. Besides the variables implicit interest payment, opportunity cost, credit risk, and interest rate risk, which were also
used by Ho and Saunders (1981), Angbazo (1997) added to the regression specic features of the nancial institutions, such as liquid-
ity risk, quality of the administration, and capital requirement.
The results showed that the net interest margins are positively related to credit risk, risk premium of the interest rate, capital re-
quirement, opportunity cost of the reserves, and management quality. Furthermore, it is negatively related to liquidity risk. Based on
Ho and Saunders (1981), Angbazo (1997), and on other empirical studies about banking spreads in the Brazilian economy, the starting
equation for the empirical evidence is represented by3:

lnMit 0 1 lnILiqit 2 lnAdmit 3 lnRecit 4 lnICobit 5 lnTribit 6 lnRCredit


7 lnMktit 8 lnQualit 9 lnOportit 10 lnPgImpit 11 lnIHHt 12 lnSelict 1
13 lnVolSelicit 14 lnIPCAt B15LnPIBt i it

3
Other recent empirical evidences based on Ho and Saunders (1981) and its extensions include Valverde and Fernandez (2007), Hawtrey and Liang (2008), Gelos
(2009) and Lopez-Espinosa, Moreno, and Perez de Gracia (2011).
32 F.D. Almeida, J.A. Divino / International Review of Economics and Finance 40 (2015) 2939

where Marg = net interest margins of the banks, 0 = constant representing the pure spread, ILiq = liquidity index, Adm =
administrative expenses, Rec = revenue from services, ICob = coverage index, Trib = tax expenses, RCred = credit risk,
Mkt = market-share, Qual = management quality, Oport = opportunity cost, PgImp = implicit interest rate payment, HHI =
index of banking concentration, Selic = basic interest rate, VolSelic = volatility of the basic interest rate, IPCA = consumer ination,
and GDP = gross domestic product of the economy. The measurement of these variables is detailed in the next section.
From this general equation, we will apply a general-to-specic modeling strategy in order to identify the relevant variables which
are able to explain the bank spread in the Brazilian economy. We chose to work with panel data because of the signicant expansion in
the degrees of freedom and possibility of controlling for bank specic heterogeneity in the estimation process. Panel data allows
controlling for unobserved individual characteristics as well as for aggregate time effects, which do not vary among individuals.
Some care, however, should be taken to ensure the robustness of the estimates. The rst one refers to the potential correlation
between regressors and individual-specic heterogeneity, appearing in the format of either xed or random effects. The second
one concerns to the stationarity of the panel, which is a requirement for the application of the asymptotic theory.
The Hausman test allows to identify if the static panel has xed or random effects, evaluating the correlation between the
individual-specic heterogeneity and the explanatory variables. Rewriting Eq. (1) in a compact form, the test considers the following
representation:

Yit Xit Zt i it 2 2

where the dependent variable, Yit is a function of time varying individual-specic characteristics, Xit, time-varying characteristics,
which are constant among individuals, Zt, and a composed error-term, i + it.
The individual heterogeneity, i, captures all unobserved factors that are time invariant and affect Yit. Generally, this term is called
xed effect. In turn, the term it represents all unobserved factors which vary among individuals and across time and affect Yit. It is
assumed that the composed error term is not correlated with Xit. For this to occur, it is not enough that it and Xit be independent,
but we must also have that i and Xit are uncorrelated. If not, the estimator will be inconsistent. The Hausman test considers the
following hypotheses:

H0 : CorrXit ; i 0 Random effects


Ha : CorrXit ; i 0 Fixed effects

The test statistic follows a 2 distribution. If the null hypothesis is rejected, the model should be transformed to eliminate the xed
effect, clearing the correlation between regressors and the individual specic heterogeneity. This transformation can be done in three
different ways, represented by rst difference, average centered data, and regression on individual dummy variables. If the null hy-
pothesis is not rejected and the conclusion is for random effects, the efcient estimator is given by feasible generalized least squares.
It will be also evaluated if there is any persistence in the bank interest margins by estimating a dynamic panel. In terms of Eq. (3),
this is done by including the lagged dependent variable among the regressors, yielding:

Yit Yit1 1 Xit Zt  i it 3

The estimation of a dynamic panel, however, brings an additional complication because the lagged dependent variable is correlat-
ed with the compound error term, even if you assume that the residuals are not autocorrelated. Therefore, the estimation of a dynamic
panel demands a specic approach, as outlined by Arellano and Bond (1991) and Arellano and Bover (1995).
The Arellano and Bond (1991) estimator eliminates the individual xed effects by transforming the regression in rst difference
and using GMM to estimate the parameters, being known as Difference GMM. The Arellano and Bover (1995) and Blundell and
Bonde (1998) estimator corresponds to an extension of the Arellano and Bond (1991) estimator, combining a system of regressions
in differences with regressions in levels. It is known as System GMM. The instruments used for the regressions in differences are still
the ones proposed by Arellano and Bond (1991). In turn, the instrumental variables for the level regressions are composed by lags of
the rst-difference explanatory variables. Thus, Blundell and Bonde (1998) show that, under the assumption of stationarity of the
panel, their estimator is more efcient than the original Arellano and Bond (1991) estimator.
Since consistency depends on the orthogonality of the instruments, one should perform the Sargan overidentication test to check
if the instruments, as a group, are exogenous. Given that the Sargan statistic is not robust to heteroskedasticity and autocorrelation,
one should also apply the Hansen test, which is not subject to those limitations. Hansen's statistic follows a 2(q k) distribution,
where q and k are, respectively, the number of moment conditions and estimated parameters.
Regarding to the autocorrelation, the test proposed by Arellano and Bond (1991) is applied to the rst difference of the residuals.
Typically, the null hypothesis of no rst-order autocorrelation is not rejected. However, this is not considered a problem because
i,t = i,t i,t 1 might be correlated with i,t 1 = i,t 1 i,t 2 given that both share the common term i,t 1. Therefore,
one must also perform the test for second order autocorrelation, AR (2). Non rejection of the null hypothesis indicates that the mo-
ment conditions are valid.
The stationarity of the time series present in Eq. (3) will be assessed by the tests proposed by Elliott, Rothenberg, and Stock (1996)
and Ng and Perron (2001). These tests, which correspond to MADFGLS and MPPGLS, use GLS to extract deterministic terms from the se-
ries and the modied Akaike information criteria to select the autoregressive order of the truncation term in the test equations. They
have better statistical properties than the original ADF and PP test, including smaller size distortion and higher statistical power. The
F.D. Almeida, J.A. Divino / International Review of Economics and Finance 40 (2015) 2939 33

presence of structural breaks, a common feature of the Brazilian time series, might affect the performance of the unit root tests. The
test by Perron (1989), characterized by exogenous selection of the break period, will be applied to address this issue. In the panel data
environment, we will apply the tests proposed by Levin, Lin, and Shu (2002) and Im, Pesaran, and Shin (2003). Roughly, these tests
correspond to generalizations of the univariate DickeyFuller procedure to the panel data environment. Comparatively, the test by
ImPesaranShin, or IPS, is less restrictive than the LLC because it does not assume homogeneity among the series of the panel
under the alternative hypothesis.

3. Data

The objective of this paper is to investigate the role of the macroeconomic conditions, specic characteristics of the nancial
institutions, and features of the banking system on the ex-post spreads. The data set is composed by series from individual nancial
institutions, nancial system as a whole, and macroeconomic conditions of the country. The set of explanatory variables has as
reference Ho and Saunders (1981), Angbazo (1997), and other empirical studies for the Brazilian economy.
The data related to individual characteristics of the nancial institutions were obtained from Balance Sheets and Income
Statements (IFT). These data are published by the Central Bank of Brazil in the Quarterly Financial Information bulletin under the
documents number 7002 and 7003, respectively. It refers to 64 nancial institutions with active commercial portfolios during the
whole period of the analysis, which extends from the rst quarter of 2001 to the second quarter of 2012.4 The time period is limited
to this interval because the disclosure of the Quarterly Financial Information started in 2001:Q1 and 2012:Q2 was the last observation
available.
We chose to use the nancial institutions instead of nancial conglomerates because the latter might be formed by commercial
banks, investment banks, nance companies, leasing companies, and brokers and security dealers. As the objective of this paper is
to analyze the bank spread generated by credit operations, multiple or commercial banks with active credit portfolio are more suitable
for the empirical analysis.
The macroeconomic indicators were obtained from the Ipeadata. Variables representing the nancial system were calculated
based on data from the nancial statements. Table 1 reports a summary of the explanatory variables used in the model, as well as
their expected signs, sources, and calculation methods.
Table 2 reports the account numbers from the Financial Statements, Balance Sheets, and Income Statement as published by the
Central Bank of Brazil. These accounts were used to calculate the individual variables of the nancial system, as presented in
Table 1. The codes are the same ones that appear in the documents 7002 and 7003 of the Income Statement.
Table 2 needs some considerations. The items credit operation, leasing, and provision for doubtful accounts have two accounts. The
rst is in short-term assets and the second in long-term assets.
The earning assets is given by the sum of interbank investments, securities and derivatives, credit operations, leasing, credit
guarantees, honored collateral, and exchange portfolio, all of them classied in the short-term and long term assets. The variable
non-earning interest assets were calculated as the difference between total assets and earning assets.
The item revenues that do not earn interest are formed by the sum of revenue from services, equity in afliates and subsidiaries,
and other operating revenues. Expenses that do not earn interest are composed by personnel bill expenses, other administrative
expenses, tax expenses, and other operating expenses. Finally, the series of total loans of the nancial system, obtained from the
Central Bank of Brazil, was considered for calculating the market share.

4. Results

4.1. Unit root tests

The starting point of the empirical analysis was to check whether the panel data and the individual time series are stationary. For
the panel data, as described in Section 2, it was performed the unit root tests proposed by Levin et al. (2002) and Im et al. (2003).
Shortly, these tests are labeled as LLC and IPS, respectively. Among the two, the IPS is less restrictive because it allows for heteroge-
neity in the rst-order autoregressive parameter under the alternative hypothesis. Serial correlation may be present in the residuals,
in which case it is eliminated by including an augmented component in the test equation.
The results are reported in Table 3. Each equation includes 4 lags in the augmented term in order to eliminate potential serial
correlation. This lag selection is in accordance with the quarterly frequency of the variables. The test equations for the LLC and IPS
also include the deterministic terms listed in the table.
One can see, from Table 3, that there is no evidence of a unit root in the series under consideration. The results indicate rejection of
the null hypothesis under the standard 5% signicance level for all series in at least two out of four estimated models. These ndings

4
The nancial institutions are: Banco do Brasil, BRB - Banco de Braslia, Banco Pottencial, Caixa Econmica Federal, Banco Ribeiro Preto, Banco BGN, Banco Rabobank
Intl Brasil, Banco Cooperativo Sicredi, Banco BNP Paribas Brasil, HSBC Bank Brasil, Bancoob, Hipercard BM, Banco CR2, Banco da Amaznia, Banco do Est. Do PA, Banco
Bradesco Financ., Banco do Nordeste do Brasil, Banco Industrial e Comercial, Banco do Est. de SE, Paran Banco, Banco BBM, Banco Mercantil do Brasil, Banco Triangulo,
Banco Banestes, Banco ABC Brasil, Banco BTG Pactual, Banco Modal, Banco Guanabara, Banco Industrial do Brasil, Banco La Nacion Argentina, Banco Rural, Banco Cdula,
Banco Cacique, Banco Citibank, Banco Brascan, Banco Rep Oriental Uruguay, Banco Arbi, Banco Safra, Banco Fibra, Banco Luso Brasileiro, Banco Panamericano, Banco
Votorantim, Banco Tokyo-Mitsubishi, Banco Sumitomo Mitsui Brasil, Ita Unibanco, Banco Bradesco, Banco Pecnia, Banco Sosa, Banco Indusval, Banco Westlb Brasil,
Banco BMG, Banco Ficsa, Banco Paulista, Banco Pine, Banco Daycoval, Banco Cifra, Banco Rendimento, Banco Bonsucesso, NBC Bank Brasil, Banco Santander, Banco John
Deere, Banco do Est. do RS, Banco A.J. Renner, Banco Original.
34 F.D. Almeida, J.A. Divino / International Review of Economics and Finance 40 (2015) 2939

Table 1
Denition of the variables.

Variable Exp. sign Sourcea Computation

Gross margin Dep. var. IFT M Revenue fromRevenue


credit operationsCredit funding expenses
from credit operations
Credit risk + IFT Rcred Provision for loan operations
Gross credit operations
Liquidity index + IFT ILiq Current
Current assets
liabilities
Administrative expenses + IFT Adm Administrative expenses
Total assets
Revenue from services IFT Rec Revenue from services
Total assets
Coverage index + IFT ICob Administrative
Revenue from services
expenses
Tax expenses + IFT Trib Tax expenses
Total Assets
Market-share + IFT Mkt Total CreditCredit operations
operations from the S FN
Management quality + IFT Qual Earning assets
Total assets
Opportunity cost + IFT Oport Non earning assets
Earning assets
Implicit interest payment + IFT PgImp No interest expensesNo interest revenue
Earning assets
Size + BCB 1 for big banks and 0 otherwise
Nationality BCB 1 for foreign banks and 0 otherwise
Capital source BCB 1 for public banks and 0 otherwise
HHIHerndahlHirschaman index + BCB n
 2
Credit operationit
HHI
i1 Total Credit Operationt
Selic rate + BCB Selic interest rate
Interest rate volatility + Authors' calculation Moving standard-deviation of the Selic rate,
considering the last 4 quarters
Consumer price index (IPCA) + IBGE Quarterly ination rate
Gross domestic product (GDP) + IBGE Quarterly real GDP

Notes: BCB = Central Bank of Brazil. IFT = Income Statement. IBGE = Brazilian Institute of Geography and Statistics.
a
The variables whose source is the IFT were computed based on the balance sheets.

are maintained as evidence that all series in the panel are stationary. This is in accordance with the assumption of stationarity found in
most of the empirical literature on banking interest margins.
The time series which appear in Eq. (1) were tested for the presence of unit root by the tests proposed by Elliott et al. (1996),
Perron and Ng (1996), and Ng and Perron (2001). These tests use GLS detrended data and the modied Akaike information criteria.
They do not suffer from size and power distortions as the traditional DickeyFuller (ADF) and PhillipsPerron (or PP) unit root tests.
Recently, Perron and Qu (2007) showed that, in the case of the PP test, OLS is more efcient than GLS detrending data. Thus, we ap-
plied the MADFGLS and MPPOLS tests. In addition, the occurrence of structural breaks was accounted for by the Perron (1989) test. This
test allows modeling one structural break in the level and/or slope of the time series, with the time of the break exogenously chosen.
The results of the MADFGLS and MPPOLS are reported in Table 4. One can see that, at the 5% signicance level, the null hypothesis of
unit root was rejected only for the interest rate volatility (VolSelic). For the other series, the presence of structural beaks might have
driven the tests results in the direction of non-rejection of the null hypothesis.

Table 2
Accounts' codes in the ofcial documents.

Item Account codes

Balance sheet accountsdocument 7002


Total assets 10.0.0.00.00.00
Current assets 10.1.0.00.00.00
Current liabilities 40.1.0.00.00.00
Gross credit operation 10.1.6.10.00.00/10.2.6.10.00.00
Leasing 10.1.7.10.00.00/10.2.7.10.00.00
Allowance for doubtful accounts 10.1.6.90.00.00/10.2.6.90.00.00
Earning assets 10.1.2.00.00.00/10.2.2.00.00.00/10.1.3.00.00.00/
10.2.3.00.00.00/10.1.6.00.00.00/10.2.6.00.00.00/
10.1.7.00.00.00/10.2.7.00.00.00/10.1.8.10.00.00/
10.2.8.10.00.00/10.1.8.20.00.00/10.2.8.20.00.00

Financial statement accountsdocument 7003


Credit funding expenses 10.1.1.10.20.12
Income from credit operations 10.1.1.10.10.11
Revenue from services 10.1.1.20.21.00
Administrative expenses 10.1.1.20.24.00
Personnel expenses 10.1.1.20.22.00
Tax expenses 10.1.1.20.26.00
No interest revenues 10.1.1.20.21.00/10.1.1.20.23.00/10.1.1.20.25.00
No interest expenses 10.1.1.20.22.00/10.1.1.20.24.00/10.1.1.20.26.00/10.1.1.20.32.00
F.D. Almeida, J.A. Divino / International Review of Economics and Finance 40 (2015) 2939 35

Table 3
Panel data unit root tests.

Variable LLC LLC IPS IPS


no const. const. const. nodemean

ILiq 16.59 5.20 2.05 1.99


Adm 10.37 5.68 0.093 1.63
Rec 11.51 4.94 1.52 1.73
ICob 13.17 1.81 1.82 1.70
Trib 14.35 7.38 1.99 1.74
RCred 13.54 8.53 1.88 2.09
Mkt 16.04 20.40 0.53 1.73
Qual 13.44 5.95 2.11 2.14
Oport 13.09 6.04 2.01 2.16
PgImp 14.10 7.97 1.86 2.02
Marg 38.15 39.82 33.67 6.36
The null hypothesis of unit root is rejected at the 1% signicance level.
The null hypothesis of unit root is rejected at the 5% signicance level.
The null hypothesis of unit root is rejected at the 10% signicance level.

Table 4
Time series unit root tests.

Variable Lags MADFGLS MPPOLS

t-Stat. 5% C. V. MZa 5% C. V. MZt 5% C. V.

VolSelic 2 2.43 1.95 10.04 8.10 2.23 1.98


SELIC 3 2.08 3.19 5.56 17.30 1.66 2.91
IPCA 6 1.61 1.95 5.43 8.10 1.64 1.98
GDP 0 1.79 3.19 3.84 17.30 1.37 2.91
The null hypothesis of unit root is rejected at the 5% signicance level. Both tests include a constant.

The previous conclusion is changed when we allow for the presence of a structural break in the apparently non stationary time
series. The results reported in Table 5, where it was considered a level shift for the series of ination (IPCA) and interest rate
(Selic) and a break in the level and in the slope of the GDP. After accounting those structural breaks, the test results indicate that
the series of IPCA, Selic, and GDP are stationary at the standard 5% signicance level.5

4.2. Static model

Initially, the model was estimated considering all variables that appear in Eq. (1), as described in Table 1. As expected, some of
them were not statistically signicant.6 Then, we applied a general-to-specic modeling strategy by excluding one variable at a
time according to its t-statistic. To be kept in the model, the variable should be statistically signicant at least at the 10% signicance
level. This strategy yielded a reduced number of explanatory variables in the nal regression. The model was estimated by xed-
effects because the Haussman test displayed a p-value of 0.0011, rejecting the null hypothesis of random effects. The results are
reported in Table 6.
The resulting model has, as signicant explanatory variables, administrative expenses (Adm), revenue from services (Rec),
coverage index (ICob), real gross domestic product (GDP), and the HerndahlHirschaman index (HHI). The rst three variables
represent individual characteristics of the nancial institutions, the GDP reects the macroeconomic environment, and the HHI
accounts for features of the banking sector.
The administrative expense was positively related to banking spread, suggesting that these costs are passed on to borrowers, in-
creasing rates of spread. This result is supported by other studies, including Koyama and Nakane (2002b), Afanasieff et al. (2002) and
Bignotto and Rodrigues (2005) Another explanation is that administrative expenses have also featured in the accounting decompo-
sitions of the ex-post spread, where they might get a relative share of up to 22%. The positive coefcient demonstrates the burden
that administrative expenses have on nancial institutions, suggesting that they deserve close attention in the bank management.
Revenue from services was negatively related to the spread. This nding differs from Afanasieff et al. (2002) and Bignotto and
Rodrigues (2005) who found this variable positively related to the spread. The negative coefcient reported in Table 6 can be ex-
plained by the fact that banking fees play an important role for the nancial institutions, helping the cost coverage and so exempting
nancial margins from these costs and enabling reductions in the spread. This nding conrms the hypothesis that banks that collect
more fees may reduce interest margins because they might rest on other sources of revenue to keep protability.

5
We considered just one structural break because this was enough to render stationarity to the time series. We could apply multiple-breaks tests, but they would not
offer any relevant information compared to the results of Table 5.
6
The results for the full model are not reported to save space, but they are available from the authors upon request.
36 F.D. Almeida, J.A. Divino / International Review of Economics and Finance 40 (2015) 2939

Table 5
Unit root test in the presence of structural break.

Variable Perron (1989)

Break period t-Stat. 5% C. V.

Selic 2005:3 19 0.39 4.55 2.83


IPCA 2002:4 8 0.15 5.17 3.90
GDP 2002:2 6 0.11 3.46 3.12
The null hypothesis of unit root is rejected at the 5% signicance level.

Table 6
Fixed-effects model.

Coef. Robust S.E. t Stat. P-value

Adm 0.65 0.33 1.98 0.05


Rec 2.55 1.34 1.91 0.06
ICob 0.14 0.03 4.23 0.00
GDP 0.05 0.02 2.96 0.00
HHI 0.76 0.35 2.15 0.03
Constant 4.76 0.26 18.35 0.00

F(63. 2875) = 2.72; P-value = 0.0000.


Wooldridge AR(1) test: F (1. 63) = 3.327; P-value = 0.0729.

The coverage index might have resulted in a key variable, given that if the bank can cover its administrative costs by using fees on
banking services, it might not have to use part of the nancial margin for that purpose. This result corroborates the hypothesis that
banks with higher coverage index have also higher spreads. In the empirical literature on the determinants of banking spread, this
is not a commonly used explanatory variable. Dantas et al. (2011) are among the few authors who found it as relevant to explain
ex-post spread in the Brazilian economy. However, for the ex-ante spread, the coverage index is usually found to be positive and
statistically signicant in the estimated models.7
The output level measured by the GDP has a positive effect on the ex-post spread, meaning that nancial institutions are able to
obtain higher interest margins in a favorable macroeconomic environment. A stable economic environment, in general, is character-
ized by lower and less volatile interest rates. This might reduce the risk of default and raise the demand for credit, which positively
impacts in the banking spread. Among the estimates based on the ex-ante spread, the effects of GDP on banking spread are ambiguous.
Afanasieff et al. (2002), for instance, found a positive relationship for the growth of industrial product and level of industrial product.
In contrast, Koyama and Nakane (2002a) obtained a negative relationship between the industrial output and the banking spread. Con-
sidering the ex-post spread, Dantas et al. (2011) identied a positive sign for the GDP, but Guimares (2002) found no signicant re-
lationship between real GDP growth and spread. Our result brings new evidence on the positive relationship between real GDP and
ex-post spread in the Brazilian banking system.
The degree of concentration of the nancial system, measured by the HHI, showed to be a variable with positive effect on the bank-
ing spread, corroborating the hypothesis by Ho and Saunders (1981). The market structure is an important element to determine the
banking spread, taking into account that a more concentrated environment might reect higher market power. This hypothesis is em-
pirically conrmed by the positive and statistically signicant coefcient of the HHI reported in Table 6.
The estimated constant was positive and highly signicant, conrming its importance in the overall composition of the banking
spread. According to Ho and Saunders (1981), the pure spread translated in the constant captures uncertainties related to mismatches
in the maturities of assets and liabilities of the banks. Because of this, banks are exposed to interest rate risk. Additionally, there is the
possibility of default by borrowers, which exposes banks to credit risk. Having to deal with these risks, banks will always demand pos-
itive interest margins represented by the pure spread. In the Brazilian economy, this margin is of 4.76% per quarter according to the
results of Table 6. This reects a relatively risky environment for banks to operate.
The diagnostic tests on the residuals indicated that the estimated model is robust. There is no evidence of serial correlation in the
residuals at the standard 5% condence level. The Wooldridge AR(1) test reported a calculated statistic of 3.33, with a p-value of 0.073.
Regarding the groupwise heteroskedasticity, the modied Wald test indicated evidence of the problem. Thus, the results presented in
Table 6 are based on the estimation of robust standard deviations, where the variancecovariance matrix is adjusted to eliminate the
heteroskedastic bias.

4.3. Dynamic model

The dynamic panel data estimation is justied because the ex-post spread holds a relationship with the stock of transactions,
reecting the entire portfolio of the nancial institution and not just the operations contracted in the current period. In addition,

7
Note that the coverage index is calculated as the ratio between revenue from services and administrative expenses.
F.D. Almeida, J.A. Divino / International Review of Economics and Finance 40 (2015) 2939 37

the dynamic model is able to capture the inertial effect which characterizes the banking spread. The estimator is based on the two-
steps GMM system due to Blundell and Bonde (1998). This model is an improved version over the original Arellano and Bond
(1995) estimator. Given that there is a considerable increase in the dimension of the instrument matrix, overidentication tests
due to Sargan (1958) and Hansen (1982) are applied to the moment conditions. The results are reported in Table 7.
The inclusion of the lagged dependent variable brought some changes to the results. Initially, we note that revenue from services is
no longer a signicant variable in the model. Then, the variable HHI was substituted by market share (Mkt). Both of them reect con-
centration in the banking sector, but market share is more bank specic than the general measure provided by the HHI. Additionally,
the lagged interest margin proved to be relevant to explain the current period spread, besides the relatively low inertial effect. Accord-
ing to the estimated coefcient, about 23% of the current spread is explained by the last period spread while 83% is due to the other
explanatory variables included in the regression. This represents an important effect, especially considering that the ex-post spread
holds a strong relationship with the stock of nancial operations made by individual banks.
For the variables which remained statistically signicant in both regressions, static and dynamic, there were only marginal changes
in the estimated coefcients. Thus, the identied coefcient for administrative expenses (1) increased from 0.65 to 0.71, coverage
index (2) marginally changed from 0.14 to 0.13, and the pure spread, measured by the constant (), moved from 4.76 to 5.04 in
the dynamic model. Another marginal change occurred in the GDP, whose estimated coefcient (1) decreased from 0.05 to 0.04.
These results indicate a relative stability of the estimated coefcients between the alternative specications.
Regarding the new variable, market share, the negative sign, although apparently counterintuitive, can be explained by the fact
that banks with higher market share in the total credit might experience gains from scale and charge lower interest margins. Thus,
in the dynamic model, the HHI was replaced by the market share because it does not capture the effects of market structure on the
spread, but only the effects coming from the economy of scale by the large banks.
It is worth mentioning the statistical irrelevance of the basic interest rate, represented by the Selic rate, in both estimated models.
In most of the studies focused on the ex-ante spread, the interest rate was a statistically signicant variable. This is due to the fact that
ex-ante spread is computed from the nancial institutions expectations for granting credit. Given that the Selic rate is highly correlat-
ed with the market interest rate, this measure of spread is much more susceptible to uctuations in the basic interest rate of the econ-
omy than the ex-post spread. In contrast, the ex-post spread is composed by actual data, which is not directly affected by changes in
expectations. Consequently, the macroeconomic environment measured by the level of real GDP becomes a more appropriate conjec-
tural variable to explain uctuations of the ex-post spread.
The diagnostic tests on the estimated residuals indicated that the model is well specied. There is no evidence of rst or second
order serial correlation in the residuals at the standard 5% condence level according to the ArellanoBond AR(1) and AR(2) tests. Re-
garding the moment conditions, both the Sargan and Hansen overidentication tests did not reject the overidentifying restrictions,
meaning that the set of instruments are orthogonal to the estimated residuals. Thus, the results reported in Table 7 are robust accord-
ing to the diagnostic tests for the dynamic panel data.
The results here obtained are compared with others studies based on ex-ante and ex-post spread for the Brazilian economy in
Table 8. In addition to conrm the importance of some traditional explanatory variable, this study stresses the relevance of some
new explanatory variables to explain the ex-post spread. It also estimates an average ex-post pure spread of about 4.9% per quarter,
considering both the static and dynamic models, for the Brazilian banking system. This value reinforces the previous claim of a rela-
tively risky environment for banks to operate in Brazil.
One can notice, from Table 8, that the studies differ in several aspects. First, they use different types of spread, represented by
ex-ante and ex-post. Another divergence occurs over the sample period, which is quite distinct among papers. Additionally, the
studies use distinct databases and, as a result, apply different methodologies. Taking together, these differences might make any
direct comparison of the results difcult. However, when comparing the results obtained from works based on the ex-post
spread, the present study adds some new evidence on the role of both micro and macroeconomic variables to explain the ex-
post spread. This spread depends not only on the macroeconomic environment in which the nancial sector is inserted but
also on the market structure of the banking sector. It is also noticed the importance of an active and efcient banking manage-
ment to improve the nancial results.

Table 7
Dynamic panel.

Variable Coef. Estim. S.E. t Stat. P-value Coef. Estim.

Mt 1 0.23 0.13 1.81 0.08 0.23


Adm (1 )1 0.55 0.31 1.76 0.08 1 0.71
ICob (1 )2 0.10 0.05 2.17 0.03 2 0.13
Mkt (1 )3 0.12 0.07 1.69 0.10 3 0.16
GDP (1 )1 0.03 0.02 1.45 0.15 1 0.04
Constante (1 ) 3.88 0.65 6.00 0.00 5.04

ArellanoBond AR(1): p-value = 0.236.


ArellanoBond AR(2): p-value = 0.170.
Sargan overidentication test: p-value = 1.000.
Hansen overidentication test: p-value = 1.000.
38 F.D. Almeida, J.A. Divino / International Review of Economics and Finance 40 (2015) 2939

Table 8
Estimated models of spread for the Brazilian economy.

Paper Period Spread Signicant variables (sign)

Aronovich (1994) 19861992 Ex-ante Ination(+), economic shocks(+)


19861992 Ination(+), level of activity()
Koyama and Nakane (2002a) 19962001 Ex-ante CPI(+), industrial product(), Selic rate(+), spread over treasury(+), taxes(+),
reserve requirement(+), administrative expenses(+)
Koyama and Nakane (2002b) 19942001 Ex-ante Selic rate(+), spread over treasury(+), taxes(+),reserve requirement(+),
administrative expenses(+)
Afanasieff et al. (2002) 19972000 Ex-ante Operational expenses(+), revenues that do not earn interest(+), revenue from services(+),
foreign banks()
19972000 CPI(), growth of the industrial product(+), selic rate(+), spread over treasury(+), taxes(+)
Guimares (2002) 19952001 Ex-post Foreign banks(), short run deposits(+)
Bignotto and Rodrigues (2005) 20012004 Ex-ante CPI(), selic rate(+), administrative expenses(+), interest rate risk(+), credit risk(+),
market share(), liquidity(+), revenue from services(+), reserve requirement(+), total asset(+)
Dantas et al. (2011) 20002009 Ex-post Credit risk(+), market share(), HHI(+), GDP(+)
This study 20012012 Ex-post Administrative expenses(+), revenue from services(), coverage index(+),
market share(), HHI(+), GDP(+)

5. Concluding remarks

The objective of this paper was to identify the major determinants of the ex-post banking spread in the Brazilian economy.
Specically, we evaluated the role played by distinct variables, representing effects coming from the macroeconomic environment,
specic characteristics of nancial institutions, and the banking system as a whole. The sample was given by a balanced panel data
composed by 64 nancial institutions in the period from the rst quarter of 2001 to the second quarter of 2012. The estimated regres-
sions had as reference the theoretical model proposed originally by Ho and Saunders (1981) and some of its extensions in the liter-
ature, including Hancock (1985), McShane and Sharpe (1985), Allen (1988), Zarruk (1989), Zarruk and Madura (1992), Angbazo
(1997), and Wong (1997).
The estimation procedure considered both static and dynamic panel data regressions. The static model was, initially, estimated
by pooled OLS. Then, the Haussman test indicated the existence of individual xed effects in the regression. The dynamic model ap-
plied the estimator proposed by Blundell and Bonde (1998). The complete regression included all variables available in the dataset. A
general-to-specic methodology was sequentially applied to eliminate variables which were not statistically signicant in the regres-
sion. As a result, the nal regression included variables representative of three categories mentioned earlier. The individual bank char-
acteristics were represented by administrative costs, revenue from services, and the coverage ratio. The effects of the macroeconomic
environment were captured by the real GDP. Finally, the variable HHI accounted for features linked to the banking sector, which might
be personied in the degree of concentration of the nancial system. Furthermore, the pure spread was also measured in the estimat-
ed regressions, appearing as an important element in the composition of the total ex-post interest margins.
We found that administrative expenses, revenue from services, coverage index, total output measured by the GDP, and the
HerndahlHirschaman index were the major determinants of the ex-post banking spread in the static model. All variables, but rev-
enue from services, showed a positive relationship with the ex-post spread. The negative coefcient for revenue from services might
be explained by the fact that banking fees contribute to cost coverage and maintenance of the nancial margins, enabling reductions in
the interest spread. This result suggests that banks that charge higher fees might practice a policy of lower ex-post interest spread.
The inertial feature of the banking spread was captured by the estimation of a dynamic panel data model. The ex-post spread holds
a close relationship with the stock of transactions, which reects the entire portfolio of the nancial institution and not just the current
period operations. The estimated coefcient for the lagged dependent variable indicated that about 23% of the current spread is ex-
plained by the last period spread while 83% of its value is determined by changes in the other explanatory variables, represented
by administrative expenses, coverage index, market share, and GDP. This is an important inertial effect, especially considering that
the ex-post spread holds a relationship with the stock of nancial operations made by the individual banks. Moreover, the variable
representing the banking system, HHI, was replaced by market-share with reversal sign for the estimated coefcient. This is due to
the fact that market share does not capture the effect of market structure on the spread, but the effect of economies of scale arising
from the size of the individual banks.
It is worth mentioning the absence of the variable interest rate in the estimated models. This happened because, differently from
the ex-ante spread which depends from expectations on granting credit, the ex-post spread is based on actual data, not being signif-
icantly affected by changes in the banks' expectations. Thus, the conditions of the macroeconomic environment are better captured by
the real GDP, which becomes a more relevant conjectural variable to explain the ex-post spread. The overall pure spread, measured as
the average from the static and dynamic estimates, was 4.9% per quarter. This is a relatively high value, suggesting that banks consider
the Brazilian economy a risky environment to operate.

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