Bank Lending Channel in Brazil

Financial institutions
Financial Economics

Monetary policy affects economic activity through different channels. One mechanism is the credit channel, that is, how monetary policy influences the real sector through its effect on the functioning of credit markets.1 There are two types of credit channels: the broad credit channel and the bank lending channel. The former is the channel through which monetary policy affects the balance sheet of lenders and borrowers in the economy. With regard to the latter, banks fund a significant part of their operations through deposits, as these are normally the cheapest source of funding. Because deposits and other sources of funding are less-than-perfect substitutes, monetary policy will shift the supply schedule of bank credit, insofar as it affects the amount of deposits in the banking system. This transmission mechanism is known as the bank lending channel.

The first empirical papers that tried to identify the bank lending channel used aggregate quarterly data.2 Dissatisfaction with identification based on aggregate data led researchers to use bank-level data. Kashyap and Stein use bank characteristics to identify the bank lending channel.3 In particular, they assume that smaller banks have more difficulty raising funds in money markets than larger banks and, thus argue that differences in the reactions of small and large banks to changes in monetary policy can be interpreted as evidence of the bank lending channel. In fact, these authors are always testing the joint hypothesis that the bank lending channel is at work and that larger banks have a better ability to substitute deposits.

However, banks with different characteristics serve different clients.4  Large banks tend to serve large corporations, while smaller banks tend to supply credit to small and medium-sized enterprises (SMEs). As large corporations have better access to capital markets than SMEs, they have a more elastic credit demand than SMEs. Therefore, large banks would lose market share to bond markets if they were to tighten credit in response to a shock in monetary policy. Differences in the type of clients served by large and small banks could thus generate the results in Kashyap and Stein even if in the absence of a bank lending channel.

In a recent paper, we contribute to the empirical understanding of the bank lending channel by employing a sharper identification strategy.5 We use daily bank-level data on interest rate and quantity and isolate supply from demand shocks by recognizing that supply reacts faster than demand to monetary shocks.

Demand for credit depends on investment and consumption decisions that do not react immediately to changes in monetary policy. In contrast, banks’ costs of funds increase immediately (on the following working day) in response to an increase in the basic interest rate. Thus, by looking at a short window around Brazil’s Monetary Policy Committee (COPOM) meeting, we hold demand constant.

Other features of our data help in identifying the bank lending channel. Shifts in credit demand and supply caused by monetary policy have, in theory, opposite effects on credit interest rate. Through the demand channel, a tightening of monetary policy reduces the equilibrium rate. Through the supply channel, interest rates increase. Hence, we corroborate our identification strategy by looking at the sign of the reduced form impact of monetary policy on lending rates. We also use data on several types of loans because the bank lending channel could be very different for different types of credit. By looking at the same product across banks, we are able to control for the fact that different credit products may have different demand elasticities.

We reach two important findings. First, we document the bank lending channel directly. Credit volume and interest rate respond strongly to monetary policy changes in the direction one would expect if we were estimating a supply response: after basic rate increases, the bank interest rate increases and credit volume contracts. Second, we investigate whether bank structure matters for the transmission of monetary policy. In contrast with existing literature, we find that, in Brazil, larger banks react more strongly to monetary policy than smaller banks. Responses are similar among foreign- and domestic-owned banks and private versus government-owned banks.

Decomposing the impact of monetary policy according to bank size is interesting for two reasons. First, it is an important policy question per se, in light of recent structural changes in the banking market. In particular, mergers in Brazil and other countries have produced larger banks. This suggests that monetary policy should become more powerful.

The second reason is identification. Part of the empirical literature typically assumes (without showing empirically) that large banks have better access to deposit substitutes because of informational and monitoring factors.6 These papers then proceed to investigate whether large and small banks respond differently to shocks in monetary policy. They typically find that larger banks are less sensitive than small ones and interpret this as evidence in favor of the theory. We emphasize that, if supply is assumed to react faster than demand to shocks in monetary policy, it is not necessary to resort to assumptions about how size determines the ability to solve informational and monitoring problems.

Why are bank-size results different in Brazil and the United States? We cannot answer this question definitively, but we may speculate. The empirical literature typically assumes as a valid hypothesis that large banks have better access to deposit substitutes for informational reasons. In Brazil, larger banks are not necessarily more transparent than smaller banks. Several small banks are publicly traded and receive wide coverage from sell-side analysts, whereas some of the largest banks are not publicly traded (or the Brazilian operation is not listed separately), including Caixa Econômica Federal, HSBC, SAFRA, and, until very recently, Santander.

Moreover, in contrast to U.S. banks, smaller banks do not necessarily suffer more informational problems. Numbers also make a difference. The Brazilian bank market has some 230 players (versus more than 7,000 in the United States). Large institutional depositors in Brazil may be able to monitor a large proportion of small and mid-sized banks. In addition, in Brazil small banks have a more concentrated deposit base than large banks. It is therefore unclear whether moral hazard problems plague smaller or larger banks.

In summary, the informational content of the bank lending channel may still be operative, but it may well work the other way around in Brazil.

Our results are important in terms of policy implications. We find that large banks are more sensitive to monetary policy than smaller ones. With bank concentration increasing over time (a phenomenon not particular to Brazil), our results suggest that in the future monetary policy will have more power through the credit channel.

Disclaimer: the views expressed in this article are strictly personal and do not necessarily represent the views of Banco Central do Brasil or Pontifícia Universidade Católica do Rio de Janeiro.


Arena, Marco, Carmen Reinhart, and Francisco Vázquez. 2007. “The Lending Channel in Emerging Economies: Are Foreign Banks Different?” Working paper WP/07/48. Washington: International Monetary Fund.

Bernanke, Ben, and Alan Blinder. 1988. “Credit, Money, and Aggregate Demand.” American Economic Review 78(2): 435–39.

———. 1992. “The Federal Funds Rate and the Channels of Monetary Policy Transmission.” American Economic Review 82(4): 901–21.

Bernanke, Ben, and Mark Gertler. 1989. “Agency Costs, Net Worth, and Business Fluctuations.” American Economic Review 79(1): 14–31.

Bernanke, Ben, Mark Gertler, and Simon Gilchrist. 1999. “The Financial Accelerator in a Quantitative Business Cycle Framework.” In Handbook of Macroeconomics, vol. 1C, edited by John B. Taylor and Michael Woodford. Amsterdam: North-Holland.

Berger, Allen, and others. 2005. “Does Function Follow Organizational Form? Evidence from the Lending Practices of Large and Small Banks.” Journal of Financial Economics 76(2): 237–69.

Christiano, Laurence, Martin Eichenbaum, and Charles Evans. 1999. “Monetary Policy Shocks: What Have We Learned and to What End?” Handbook of Macroeconomics, vol. 1A, edited by John B. Taylor and Michael Woodford, pp. 65-148. Amsterdam: North-Holland.

Coelho, Christiano, João De Mello and Márcio Garcia. 2010. “Identifying the Bank Lending Channel in Brazil through Data Frequency.” Economia, 10(2): 47-74.

Kashyap, Anil, and Jeremy Stein. 1994. “The Impact of Monetary Policy on Bank Balance Sheets.” Working paper 4821. Cambridge, Mass.: National Bureau of Economic Research.

———. 2000. “What Do a Million Observations on Banks Say about the Transmission of Monetary Policy?” American Economic Review 90(3): 407–28.

Kashyap, Anil, Jeremy Stein, and David Wilcox. 1993. “Monetary Policy and Credit Conditions: Evidence from the Composition of External Finance.” American Economic Review 83(1): 78–98.

Kiyotaki, Nobuhiro, and John Moore. 1997. “Credit Cycles.” Journal of Political Economy 105(2): 211–48.
Stein, Jeremy. 1998. “An Adverse-Selection Model of Bank Asset and Liability Management with Implications for the Transmission of Monetary Policy.” Rand Journal of Economics 29(3): 466–86.

Stiglitz, Joseph E., and Andrew Weiss. 1981. “Credit Rationing in Markets with Imperfect Information.” American Economic Review 71(3): 393–410.

1Bernanke and Blinder (1988); Bernanke and Gertler (1989); Bernanke, Gertler, and Gilchrist (1999); Kiyotaki and Moore (1997).
2Bernanke and Blinder (1992) and Kashyap, Stein, and Wilcox (1993.
3Kashyap and Stein (1994); Kashyap and Stein (2000);
4Berger and others (2005).
5Coelho, De Mello and Garcia (2010).
6Kashyap and Stein (2000); Arena, Reinhart, and Vázquez (2007).

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