- Highly concentrated and insufficiently competitive banking systems in Latin America and the Caribbean result in scarce and expensive credit.
- This leads to less innovation, weaker incentive to expand services to underserved borrowers, and high borrowing costs for SMEs.
- Digital payment platforms and reforms leading to loan portability and interoperable payment systems could increase competition and expand access to finance while safeguarding savings.
Access to affordable finance is fundamental to economic development. Firms need credit to invest and grow, and households rely on loans to weather income fluctuations, buy homes, or finance education. Yet across Latin America and the Caribbean, credit remains scarce and expensive, largely because competition in banking is limited.
Banks in the region are profitable, often strikingly so. But high profitability does not necessarily signal efficiency. Instead, it may reflect concentrated market structures in which a small number of large institutions dominate lending. When competition is weak, the cost of borrowing rises, access narrows, and economic dynamism suffers.
This is one key message of the IDB’s latest Development in the Americas report, Markets for Development: Improving Lives through Competition, which offers several recommendations on increasing competition in the banking sector, including the promotion of better credit information, more interoperability in payment systems, and deeper capital markets.
Banking System Concentration
Banking systems in Latin America and the Caribbean tend to be highly concentrated. In many countries, the five largest banks control the bulk of financial assets. Profitability indicators, such as returns on assets and equity, are systematically higher than in advanced economies. Interest rate spreads, the gap between lending and deposit rates, are also wider.
Part of this reflects macroeconomic volatility, default risk, and weaker contract enforcement. But these structural factors do not fully explain the gap. Market power plays a significant role. When a handful of banks dominate lending, they face less pressure to reduce spreads, innovate, or expand services to underserved borrowers. The result is a financial system that is stable but insufficiently dynamic.
Limited Banking Competition Increases Borrowing Costs
For firms, especially small and medium enterprises (SMEs), limited banking competition translates directly into higher borrowing costs. High spreads raise the hurdle rate for investment. Projects that would be profitable under lower interest rates never take off. Entrepreneurs delay expansion, and informal firms remain small rather than formalizing and scaling up.
Credit constraints, in this way, distort key economic relationships. Larger, well-connected firms secure financing more easily while smaller or younger firms struggle to access loans at any price.
These dynamics reinforce the problem of the region’s “missing middle”: an abundance of microenterprises and a small number of large firms, with too few growing businesses in between. Households face similar barriers. With mortgage markets shallow and consumer credit costly, financial exclusion remains widespread, particularly among low-income populations.
Fostering Competition While Promoting System Stability
Expanding banking competition is sometimes viewed with caution as policymakers worry that it could undermine financial stability by encouraging excessive risk-taking. But increasing competition is critical. It allows finance to play its allocative role, directing capital toward the most productive uses.
Moreover, it can be accompanied by effective and stabilizing regulation through supervisory frameworks, capital requirements, and resolution regimes. Indeed, excessive concentration may itself create systemic risk by producing institutions that are “too big to fail.”
The Promise of Digital Disruption
While traditional banking systems have been slow to open up, digital technologies are beginning to force important changes. Fintech entrants, in particular, are helping reshape financial services across the region. By leveraging data, mobile platforms, and lower operating costs, they are reaching clients historically excluded from formal finance. Regulations that encourage Fintech entry could further encourage this positive development.
Instant payment systems, meanwhile, are reducing transaction costs, expanding financial footprints, and generating data trails that improve credit scoring. As more individuals and firms transact digitally, information asymmetries decline, making lending less risky and more competitive.
Policy Priorities
Other reforms, emphasized in the book, can also diminish banking incumbents’ market power and inject energy into the economy, thus playing an essential role in development. They can help ameliorate a situation in which competition is limited, capital flows disproportionately toward connected incumbents rather than promising and dynamic entrants, and shallow credit markets constrain productivity growth, dampen job creation, and reinforce inequality.
Credit information systems, for example, can be strengthened so that lenders can assess risk more accurately, helping reduce risk premiums and lower barriers to entry for new institutions.
Promoting interoperability in payment systems would help prevent incumbents from controlling the gateways through which households and firms access financial services, widening participation and intensifying competitive pressure.
Facilitating loan portability can allow borrowers to move their loans across institutions with fewer administrative and legal hurdles. Switching costs would fall, as a result, and lenders would be forced to compete more aggressively on price and service quality.
Finally, capital markets must be deepened to reduce reliance on concentrated banking systems and broaden firms’ funding options.
None of these reforms alone is transformative. Taken together, however, they can meaningfully reshape competitive dynamics in financial markets. The region’s banking systems are, in many respects, success stories, more stable and better regulated than in past decades. But stability is not enough.
For finance to support development, it must also be competitive, inclusive, and innovative, with lower spreads, broader access, and greater contestability that allows credit to flow toward the entrepreneurs and households who need it most. More competition is essential to allowing banking systems to better finance growth while safeguarding savings. In economies where capital remains scarce and costly, that could make all the difference.