The Value of Countercyclical Capital Requirements: Evidence from COVID-19

Abstract

We evaluate the implications of relaxing the Supplementary Leverage Ratio during the COVID-19 market disruption for bank balance sheet composition and credit provision. To the best of our knowledge, we are the first to causally identify the effect of the SLR regulation change on bank level outcomes. We find that the relaxation may have eased Treasury market liquidity by allowing banks to hold modestly greater inventories of Treasuries, and further allowed for a significant expansion of traditional bank credit. Our findings suggest that this risk-invariant leverage ratio was binding for banks during COVID-19, weakly affected bank liquidity provision in Treasury markets, and strongly affected banks' portfolio composition across asset classes, amounting to a shift of banks' loan supply schedules. Thus, we highlight that countercyclical relaxation of uniform leverage constraints can increase bank credit provision during economic downturns. Given the binding nature of the SLR, the relaxation of this constraint may be more effective than other countercyclical measures in allowing banks to extend credit.