The ceilings on payroll and overdraft interest – 03/21/2023 – Bernardo Guimarães

The interest ceiling of 1.7% per month on payroll loans was a fiasco. As soon as it entered into force, banks suspended credit concessions in this modality.

This was not the case in January 2020, when the Central Bank instituted an interest ceiling on overdrafts of 8% per month for individuals. As the table shows, the average rate for individuals fell by four percentage points (because of the ceiling), while the rate for corporations did not change.

Interestingly, the amount of credit for individuals and companies has behaved very similarly since then (note the large drop in credit with the pandemic).

Unlike what happened now, the interest ceiling on the 2020 overdraft did not significantly change the credit offer.

Why did interest rate ceilings have such different effects?

To answer that, we first need to understand the reason for the high interest rates for people and companies in Brazil.

The high default explains part of the problem. If many do not pay their debts in full, the interest they pay must compensate the bank for losses on other loans.

Payroll loans allow people to pledge their future wages as collateral for loans. Effectively, the chances of default are much smaller. In fact, interest rates on these types of loans are much lower, and there is solid empirical evidence showing that loan rules —which make it difficult to default— explain much of this difference.

However, as the Central Bank’s Banking Economy Report shows, defaults are only part of the story. The bank’s margin, in general, is large.

If the difference between the cost to banks and the lending rate (the so-called spread) is too high, the fault lies with the lack of competition between financial institutions.

What factors affect bank competition?

Generally speaking, there is more competition when it is easy to switch to another provider of a good or service.
So, in a world where defaulting is very difficult and the default rate is very low, competition must be fiercer. After all, in this case, a borrower quickly obtains loan proposals from other institutions and can choose the lowest interest rate.

On the other hand, if there is a lot of default, an institution will be more apprehensive and take longer to grant credit to a stranger. Thus, the bank that knows the customer can charge a higher fee without losing him.

One implication is that competition must be much fiercer in the payroll loan market than in overdraft. Thus, the banks’ margin should be much smaller. This would explain the very different effects of interest rate caps in 2020 and 2023.

In fact, the BC’s Banking Economy Report shows that payroll is one of the credit markets with the least concentration —that is, more competition. This tends to lead to a smaller spread.

The interest ceiling on the overdraft in 2020 was justified by a very good BC technical note. The note argued, with theory and data, that the demand for overdraft credit was very little sensitive to interest rates and competition was not strong enough.

On the other hand, the 2023 ceiling seems to come in a wave of contempt for BC economics books and technical reports.

There is much room for improvement in the Brazilian credit market. Researchers are discreet and silent, but their books, scientific articles and technical notes bring a lot of information to those formulating public policies.

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