Bank Size and Loan Type Shape How Brazil’s Policy Rates Impact Lending Costs

In a new IMF Working Paper, economists Daniel Leigh and Rui Xu, drawing on insights from institutions such as the Central Bank of Brazil (BCB), Brazil’s Ministry of Finance, and the IMF’s Monetary and Capital Markets Department, delve into an increasingly puzzling phenomenon: why has Brazil experienced a surge in credit growth despite enduring double-digit interest rates since 2022? Their investigation explores whether Brazil’s monetary policy transmission, the process through which central bank interest rate changes affect borrowing costs for households and firms, is still working effectively. Using new high-frequency data and bank-level lending statistics, their findings suggest that while the transmission channel remains intact, it is influenced by critical structural dynamics and diverges sharply across different credit markets.

Policy Shocks from Forecast Misses: A Novel Approach

To assess how much monetary policy decisions move lending rates, the authors use a creative empirical strategy. They rely on Brazil’s daily Focus survey, which collects market expectations from over 170 financial institutions. By comparing actual policy rate decisions (SELIC) to forecasts made just one day prior, they isolate unexpected monetary shocks. These forecast surprises serve as the key input to their analysis, mimicking methodologies used for central banks in advanced economies like the U.S. Federal Reserve and the European Central Bank. This allows them to sidestep the endogeneity problem, where policy moves may themselves react to economic conditions, and focus on true exogenous shifts in interest rates.

In tandem, the authors leverage daily lending rate data from approximately 80 banks and financial institutions across Brazil. These include traditional private and public banks, as well as fintech lenders and digital banks, capturing a diverse swath of Brazil’s credit landscape. Applying a local projections framework with instrumental variables, they estimate how these different types of loans and institutions respond to policy rate changes over the course of one year.

70% Pass-Through, But Earmarked Credit Lags Behind

Their central finding is striking: lending rates adjust by about 70 percent of the policy rate shock within four months. This level of pass-through is consistent with other emerging market economies and indicates that the core of Brazil’s monetary transmission system remains functional. However, the headline number conceals significant differences between credit types. Market-based lending, such as personal loans and corporate credit from banks relying on market funding, shows a full one-for-one pass-through to the policy rate. In stark contrast, government-directed, or earmarked, credit only adjusts by 20 percent. These loans, which still account for 42 percent of Brazil’s total credit stock as of 2024, are funded through constitutionally protected funds, federal programs, and tax-exempt instruments, rendering them much less sensitive to monetary tightening.

Importantly, the study finds that pass-through has strengthened since 2020, contradicting the global trend of declining monetary policy effectiveness in the post-pandemic era. This improvement is especially visible in corporate credit. For government-directed lending, the uptick is attributed largely to the 2018 reform of BNDES, which replaced its long-term subsidized rate (TJLP) with a new market-based rate (TLP). This reform brought BNDES lending rates more in line with policy rates, boosting their responsiveness.

Loan Type and Bank Size Define Responsiveness

The analysis becomes even more revealing when broken down by credit types and bank characteristics. Among corporate loans, working capital credit exhibits the fastest and strongest pass-through, peaking at 80 percent within just two months. Unsecured consumer loans, such as personal loans and credit cards, follow closely, also reaching 80 percent but over a longer horizon of four months. At the other end of the spectrum, payroll-deducted loans, including those backed by pensions or public sector wages, show minimal responsiveness, with only 40 percent pass-through over ten months. This weakness is largely explained by government-imposed interest rate ceilings. For instance, the INSS’s cap on pension-backed loan rates has remained at 2.14 percent per month since January 2022, despite the SELIC rate rising substantially. Such rigid caps limit banks’ ability to adjust lending rates in response to higher funding costs, effectively muting the policy signal.

Bank size also matters. Brazil’s five largest banks, which dominate the country’s lending landscape, show nearly full pass-through across all credit types, except for payroll loans. In contrast, smaller banks demonstrate weaker responsiveness, likely due to lower asset quality or higher perceived credit risk. Interestingly, fintechs and digital banks do not behave differently from traditional private or public banks in their policy responsiveness, suggesting that new entrants into Brazil’s financial sector are equally attuned to monetary conditions.

Structural Shifts Behind the Credit Surge

If monetary transmission remains functional, why has credit continued to expand rapidly even under tight policy conditions? The study points to significant structural shifts that have altered Brazil’s financial environment. Chief among them is the rapid expansion of the corporate bond market, fueled by legislation that exempts infrastructure, real estate, and agribusiness bonds from income and capital gains taxes. These tax-exempt debentures have made non-bank financing increasingly attractive for firms, especially in a high-rate environment. As a result, banks are pressured to offer more competitive rates, intensifying the transmission of monetary policy.

Additionally, the rise of fintech lenders and digital banks, which now account for 25 percent of credit card loans and 10 percent of non-payroll personal loans, has increased competition, improved financial inclusion, and reduced lending spreads. With traditional banks forced to innovate and become more efficient, the overall credit supply has expanded, even as policy rates remain high.