Time-Varying Capital Requirements and Disclosure Rules: Effects on Capitalization and Lending Decisions

Abstract

This paper investigates how banks’ capital and lending decisions respond to changes in bank-specific capital and disclosure requirements using proprietary regulatory data from the Danish FSA on the full population of banks in Denmark. We find that banks adjust their capital ratio via different channels, depending on the sign of the change in the capital ratio a bank is required to fulfill. An increase in the required capital ratio results in an increase in a bank’s capital ratio, brought about via a decrease in asset risk. Given that total lending as well as equity are not affected this indicates a reshuffling of loans towards those with lower risk weights. Additionally, the buffer banks choose to hold over and above the required capital ratio decreases. A decrease in the required capital ratio implies more lending to firms and a higher buffer between actual and required capital but also a decrease in Tier 1 capital and higher bank leverage. These effects are most pronounced in a regime when the required capital ratio is a “hard” requirement, meaning that the supervisor withdraws the banking license when it is breached. In contrast to the intention in Basel III, we do not observe differences between confidential and public disclosure of banks’ regulatory capital ratio requirement. Our results empirically illustrate a tradeoff between bank resilience and a fostering of the economy through more bank lending using banks’ capital ratio as policy instrument.