Economic Freedom and the Determinants of the Bank Spread in South America

Abstract

This paper performs panel data analysis to test the existence of an inverse relationship between bank spreads and the degree of economic freedom in South American countries between 2000 and 2020. In the late 1990s, South America began a process of financial sector reforms, which included in almost all countries the liberalization of interest rates (instead of capping) and the elimination of direct credit allocation mechanisms. By hypothesis, it is expected that the greater the economic freedom, the lower the degree of financial regulation. This would reduce the transaction costs of financial institutions and contribute to reducing the banking spread (assuming constant credit risk). The traditional methodology is applied here, complemented by unit root and cointegration tests, in addition to impulse-response function analysis, in the context of panel autoregressive vectors (VAR). The results show that economic freedom and monetary credibility (component area of the EFW, Economic Freedom of the World index) negatively affect the value of the spread, with long-run effects as well.