Do New Capital Requirements Make Loans More Expensive? An Empirical Study for the Colombian Banking System

Abstract

After the financial crisis Basel III Committee recommended new capital ratio regulations for the banking system. Colombian regulators adopted some of these recommendations in 2012 through the Decree 1771 of 2012, particularly regarding capital requirements applicable to banks. Some scholars claim that additional capital requirements – as the ones recommended by Basel III – make loans more expensive and also affect the expansion of lending. However, some other scholars dispute this statement. This paper tests both hypotheses relying in Colombian banks data and the results of an econometric analysis based on Differences in Differences (DID) methodology. On one hand, a model confirms the hypothesis about the correlation between capital requirements and rates of loans in Colombia. On the other hand, another model confirms the hypothesis about the correlation between capital requirements and volumes of loans in Colombia. Both models analyze data from a time series from 2006 to 2015. Part of the data was collected from the Superintendency of Financial Institutions and includes 25 banks, which represent the entire population. Some other data – the control variables – was collected from National Department of Statistics and World Bank’s database for Colombia.The conclusions provided in this paper are relevant for the Colombian financial regulator since the 2016 Colombian Unit of Financial Regulation’s agenda has the evaluation of the implementation of Basel III capital adequacy requirements as a priority. The regulator will prepare by the end of this year a document regarding this matter. Moreover, Colombia – as other emerging economies – currently faces significant financing necessities. The government pursues very ambitious goals in financial inclusion and infrastructure in the medium and long term. Regarding financial inclusion, the government expects to expand the lending activity performed by banks and concerning infrastructure; the government plans to develop huge highways across the country. The role of the banking system, as lender, in both projects is key. Therefore, this paper is relevant for the policy discussion within the Colombian financial industry. Additionally, this paper analyzes the differences between the financial system’s structure that motivated Basel III recommendations and Colombian banking system. This study will allow regulators and policy makers to measure the impact of these recommendations after being applied to underdeveloped banking systems structures. Finally, the Basel Committee is currently undertaking an ambitious revision of the Basel III recommendations. So far, the discussion focuses on the Risk Weighted Assets (RWA). New provisions regarding RWA, necessarily, will affect the capital ratios because banks will have to improve their capital in order to maintain the required ratios. The global banking industry is greatly concerned about the potential additional tightening of capital requirements due to the conservative bias in the calibration of the proposals so far published.