Brazil's Itau: Taxes, cost cuts key to lower rates

* Spread drop to obey to lower taxes, costs: Setúbal

* Says "rationality will prevail" as pressure mounts

* Comes as gov't pressures for lower borrowing costs

SAO PAULO, June 20 (Reuters) - Borrowing costs in Brazil would likely decline more quickly if lenders cut expenses and the government trimmed taxes instead of pressing banks to charge less for credit, the chief executive of Itau Unibanco, the country's largest private sector bank, said on Wednesday.

Roberto Egydio Setúbal, chief executive of Itaú Unibanco Holding, said a combination of lower taxes on loans, cuts in reserve requirements, and efforts by lenders to improve cost efficiency would be more effective in bringing down borrowing costs in Brazil, which are among the world's highest, than the government's crusade to cut banks' profits.

"There's pressure coming from all sides," Setúbal told an audience at an event sponsored by Febraban, the industry group representing banks. "But, in the end, market rationality will prevail."

Setúbal's remarks are the first by a major executive questioning the effectiveness of recent government efforts to push down borrowing costs through political pressure. President Dilma Rousseff has in at least four different speeches since April urged banks to charge less for loans as Brazil's economy struggles to regain momentum.

Rousseff has instructed state-controlled lenders to speed up disbursements and cut rates to force private sector rivals to follow suit. Some analysts say the risk of such strategy is forcing private banks to assume a less prudent stance on lending at a time when loan defaults are creeping up and economic growth slows abruptly.

Brazilian banks charge the highest spreads, or the difference between lending and deposit rates, among the world's 20 major economies. While borrowers pay an average 42 percent a year for a 1-1/2-year loan, spreads top 27 percentage points, compared with single-digit spreads in other Latin American nations.

Government pressure on commercial banks to slash interest rates led to the steepest drop in the cost of overdraft loans in April in 14 years. The average lending rate fell to the lowest level since December 2010.

According to Setúbal, a surge in net interest income in recent years stemming from a jump in credit demand will ultimately force banks to revise their cost and expense management models. Efficiency, or the share of revenue that goes to cover costs, will become the industry's new focus, he added.

Costs will be key to helping the local banking industry fight the impact of global financial turmoil, he added.

Setúbal also refuted claims Brazilian banks' earnings far outstrip their global peers. "The problem is not earning fat margins but on how sustainable your profits are," he said.