Bank response to policy-related changes in capital requirements

Abstract

We estimate how banks respond to regulatory capital requirements. We use a novel measure called capital surplus/shortfall, which we construct from notifications on regulatory capital requirements sent to Slovenian banks over the period 2009–2015. Capital surplus/shortfall is more relevant than capital adequacy ratio (CAR). It conveys more information about future lending because it is a forward-looking measure of bank capitalization. Our paper carries policy implications for supervisors in countries with a distressed banking sector. Using this measure we show that the same firm has on average a 3.54 p.p. lower loan growth when the loan is obtained through a bank with 1 p.p. higher capital shortfall. Finally, we show that in response to an increase in capital requirements banks engage in risk-taking behaviour.