Intermediation Spreads in a Dual Currency Economy-Argentina in the 1990s


WP/98/90-EAWP/98/90


Since the onset of the currency board arrangement in early 1991, interest rates
on bank deposits in Argentina have gradually converged to international levels.
Yet, a similar convergence has not been observed for lending interest rates,
which stand well above OECD levels. This is widely perceived as having had a
detrimental impact on employment in Argentina and on the external
competitiveness of its domestic industry, as most firms have continued to rely
on local banks for their financing.


This paper examines the determinants of the spread between deposit and lending
interest rates in Argentina, seeking to answer two main questions. First, why
have banking spreads remained relatively high despite the uninterrupted
operation of the currency board arrangement for seven years now and the
far-reaching liberalization and financial sector reforms that have boosted
banking sector productivity? Second, why has there been a significant gap
between interest rate spreads in domestic currency and those in foreign
currency transactions, given that banks and the general public are virtually
free to intermediate in either currency?


To identify the contribution of banks. operating costs and financial policy
variables to intermediation spreads, this paper develops a partial equilibrium
model of the banking industry in a dual currency economy with imperfectly
competitive credit markets, and estimates it empirically. The evidence
indicates that high intermediation spreads in Argentina persist as a result of
(1) high administrative costs stemming from the low monetization of the
economy, inefficiencies of the payments system, and limited consolidation of
the financial system; (2) credit risk and sizable provisioning expenses
associated with the large stock of non-performing loans, which partly reflect
institutional barriers to the dissemination of credit information; and (3)
market segmentation between domestic and foreign currency borrowers. Based on
these results, the paper discusses a number of policy recommendations to reduce
further banking spreads in Argentina.