DDP 694. Astrid Dick. "Banking Spreads in Central America: Evolution, Structure and Behavior." April 1999. 59 pp. Central America Project Series

Central American banking spreads, defined as the difference between the lending and the deposit interest rates, are generally well above those observed in developed countries with mature financial systems. This study analyzes the spread of Costa Rica, El Salvador, Guatemala, Honduras, and Nicaragua in terms of their evolution, composition, and behavior. An empirical model of spread/lending rate determination is estimated with a panel data set for each country in the region. Analysis of the structure of the spread is carried out under the descriptive framework of the income statement of banks.

The results of this analysis indicate that operating costs are the most important component within the spread, and that there is a positive association between these costs and the spread in all the Central American countries. Additionally, the degree of market power does not appear to be a key determinant in the formation of the spread, for the exception of Costa Rica.

From a policy perspective, these results suggest that reforms that provide incentives for the entrance of new participants should continue. This would increase the degree of competition in the industry and force the decrease of operating expenses (as long as the proper assessment of banking costs functions is consistent with this policy).

Keywords: banking, financial systems, spreads, reserve requirements, market power, Central America, Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua

JEL codes: G21

Astrid Dick is a PhD student in Economics at the Massachusetts Insititute of Technology.