In the sequel Nakane specifies the

In the sequel, Nakane (2001) specifies the bank behavior, assuming that a bank i is able to accumulate an amount D of deposits in real terms by committing to pay r as real interest, which is limited by a compulsory reserve rate μ. Besides the compulsory reserves, bank assets consist also by bank loans and public bonds, with r being the real interest rate charged by public bonds. Then, the bank\'s balance sheet i is given by:with B being the amount of public bonds held by the bank i in real terms. From this buy everolimus equation , we can obtain:So that:As: Eq. (2.3) defines the profit function in real terms for a single bank i, where C(L;D) is the resource cost incurred by bank i to accumulate D deposits and provide L loans. It is assumed that this cost function is additively separable in its arguments. Nakane (2001) asserts that the rate r is exogenous, which allows dealing with the deposit and loan markets separately, and disregards issues of market power. Thus, the first order condition in the loan market is: The marginal loan function can be described by:where w is the price of entry, z is a controlling factor of the quality of results, measured by loan losses, and β1, β2 and β3 are coefficients to be estimated. Consider that the controlling factor of the quality of the results, z, is represented by those that influence the volume and conditions on which credit is offered. According to Ho and Saunders (1981, pp. 587–588), z can be represented by the interest rate risk, the credit risk and the variance of the interest rate on loans and deposits, which is related to the profitability. In other words, the analysis proposed in this paper is that macroeconomic instability can affect bank spread through these channels. In recent years, a vast empirical literature regarding the determinants of banking spread has been developed with the intention of empirically testing the theoretical model of bank spread developed by Ho and Saunders (1981). Some of the most important works in this line of research are McShane and Sharpe (1985), Angbazo (1997), Saunders and Schumacher (2000) and Maudos and Guevara (2004). In this paper, the variables chosen to represent z were: the basic interest rate, the default rate for individuals and the profit rate of each commercial bank. The point of intercept incorporates the idea that the price of products and services offered must be greater than its marginal cost to make this banking firm willing to enter the market. The other variables will be incorporated as defined previously. Thus: Note that the theory of the banking firm aforementioned combines the elements developed by Nakane (2001) with elements presented by Ho and Saunders (1981), who consider the macroeconomic variables important when explaining the behavior of the rate of return on bank loans. In this proposal, the basic interest rate is used to represent the interest risk, as it is the opportunity cost for the commercial bank for lending to the public. The credit risk can be captured by the default rate of the individual. Finally, the variance of the interest rate on loans and deposits, which is related to the variation of profit. Substituting (2.5′) in (2.4): From this we obtain: Resuming Eq. (2.1): Considering that ∂L/∂L=λ: Substituting (2.7) in (2.6): The parameter λ measures the percentage of the banking market response to a 1% increase in the supply of loans by bank i. In other words, it measures the average degree of market power in the industry. If its value is equal to one, there is a case of monopoly or cartel, and if it is equal to zero, a case of perfect competition. The results found by Nakane (2001) when estimating the equations via two-stage least-squares estimator (2SLS) were as follows: (i) the bank interest spread adjusts more quickly to deviations from the long-run equilibrium than the demand for bank loans; (ii) the bank interest spread increases when the amount of extended loans rises, when the price of inputs is higher, and when default losses increase; (iii) the value obtained for the market power parameter was 0.0017, implying that Brazilian banks do not behave perfectly competitively, but also do not behave as a cartel, and its market structure remains unidentified. This last point is the main conclusion of this paper. The results also show that market power in Brazilian banking sector is more pronounced in the long-term rather than in the short-term (Nakane, 2001).