How to Make Bankers Richer: The Brazilian Financial Market with Public and Private Banks

In this paper the literature on state owned banks and on the determinants of high spread and profitability of Brazilian banks are briefly reviewed. Then the paper proceeds to forward the hypothesis that the way state owned banks have interacted with public owned banks in the market is partially responsible for such high profitability and interest rates spreads of Brazilian banking system. A model is presented to explain how this interaction can generate this profitability and spreads. The results also show that governments that stretch social policies are those that are most likely to raise profitability and spreads. Furthermore, the model also shows that if the government is generous with employees of state owned banks, it will also contribute to the profit performance of private banks and high interest rates spreads. Two empirical tests of the major hypothesis of this paper are presented. Both rely on time series data for the Brazilian economy, but one of them estimates a structural expanded CAPM model for banks, while the second one uses a Factor Augmenting Vector Auto-Regression (FAVAR) model. Both tests give support to the major hypothesis.