How does credit supply respond to monetary policy and bank minimum capital requirements?

Abstract

We use data on UK banks׳ minimum capital requirements to study the interaction of monetary policy and capital requirement regulation. UK banks were subject to both time-varying capital requirements and changes in interest rate policy. Tightening of either capital requirements or monetary policy reduces the supply of lending. Lending by large banks reacts substantially to capital requirement changes, but not to monetary policy changes. Lending by small banks reacts to both. There is little evidence of interaction between these two policy instruments. The differences in the responses of small and large banks identify important distributional consequences within the financial system of these two policy instruments. Finally, our findings do not corroborate theoretical models that raise concerns about complex interactions between monetary policy and macro-prudential variation in capital requirements.