Increase In Capital Requirements Research Articles

Community banks' capital requirements and regional housing tenure

AbstractBank capital requirements aim at reducing the likelihood of banks' failure. However, these policies may generate externalities on the overall economy. By investigating the pathways from capital requirements to housing tenure using structural equation modelling, we show that community banks' capital requirements increase the gap between the regional real estate loans‐based and non‐real estate loans‐based housing purchase rate and act as driving factors of housing market imbalance. The drop in residential real estate loans caused by the increase in capital requirements has two opposite effects: the direct effect motivates residents to rent properties, while the indirect effect motivates residents to purchase them due to the fall in housing prices. When both effects exist in housing purchases with real estate loans, the former effect is more influential than the latter one. Our findings suggest that the impact of capital requirements on housing tenure will depend on residents' reliance on real estate loans. If a housing purchase requires real estate loans, capital requirements will have a negative impact on the housing purchase, and vice versa.

Macroprudential regulatory policies with a dominant-bank oligopoly and fringe banks

This paper develops a model in which a handful of dominant banks mutually engage in head-to-head rivalry while acting as loan-quantity-setting leaders vis-à-vis numerous fringe banks. Under the most likely calibration of parameters governing behavior of the two groups, we find that increases in capital requirements substantially reduce equilibrium loan volumes and raise the market retail loan rate, while increases in tax rates tend to raise the market loan rate but not in a way that significantly alters aggregate lending. Key parameters influencing outcomes in alternative calibrations are the number of dominant banks and the market loan demand elasticity.

Capital requirements, mortgage rates and house prices

We study the effect of an increase in capital requirements for residential mortgages on mortgage rates and house prices. We exploit a unique quasi-experiment in which affected banks faced an increase in risk weights of five percentage points. Using a difference-in-differences estimator, we find that treated banks increase their mortgage rates by 19 basis points. Houses near affected banks have a 2.38% lower sale price after the increase in capital requirements. Our results imply a semi-elasticity of house prices to changes in mortgage rates of 12.3, in line with predictions from a user cost model.

CREDIT RISK OF SMALL AND MEDIUM-SIZED ENTERPRISES IN THE CONDITIONS OF THE COVID-19 CRISIS

The subject of the paper is assessment of the credit risk of small and medium-sized enterprises (SMEs) in the conditions of the COVID-19 crisis. The paper gives the overview of the theoretical and professional literature on the existing accounting standards related to the assessment of expected loss and banking regulations in terms of capital adequacy, as well as their applicability in the current crisis. Bearing in mind the share of SMEs in total gross domestic product and employment in emerging and developing markets, and dependence of these companies on bank funding, special attention is paid to the researches dealing with the impact of stress tests and an increase in capital requirements on credit supply. Since the paper was written at a time when the COVID-19 crisis was well under way, and the final effects could not be fully analysed, except for only certain projections, future researches will focus on the effectiveness of the existing credit risk assessment models in crisis conditions.

How Do Capital Requirements Affect Loan Rates? Evidence from High Volatility Commercial Real Estate*

Abstract We investigate how capital requirements affect loan rates by studying the 50% increase in the risk weight for high volatility commercial real estate (HVCRE) loans under Basel III. Exploiting variation in loan terms and exposure to the period after the rule’s implementation, we find that a one-percentage-point increase in capital requirements raises loan rates by 8.5 basis points. Using a model of bank funding costs, we demonstrate the timing and scope of the HVCRE rule implies our estimate reflects the steady-state cost of capital requirements. (JEL G21, G28, G38)

Capital Requirements, Mortgage Rates and House Prices

We study the effect of an increase in capital requirements for residential mortgages on mortgage rates and house prices. We exploit a unique quasi-experiment in which affected banks faced an increase in risk weights of five percentage points. Using a difference-in-difference estimator we find that treated banks increase their mortgage rates by 18 basis points. Houses near affected banks have a 2.34% lower sale price after the increase in capital requirements. Our results imply a semi-elasticity of house prices to changes in mortgage rates of 13, in line with predictions from a user cost model.

Dynamic Bank Capital Regulation and Optimal Macroprudential Policies in the Presence of Non-Regulated Financial Intermediaries

I embed shadow banks, i.e. financial intermediaries without regulatory oversight, in a quantitative general equilibrium model in which both regulated banks and shadow banks finance firms that have production technologies with different riskiness. In the model, shadow banks 1) do not have deposit insurance, 2) do not face capital regulation, and 3) have a relatively lower price of taking risk compared with regulated banks. Limited liability and deposit insurance can lead regulated banks to provide socially inefficient risky loans; this excessive risk-taking can be activated by economic shocks that reduce the return on safer loans and can be prevented by higher bank capital requirements at the cost of lower liquidity provision. I propose a novel channel that additionally boosts excessive risk-taking incentives associated with migration of credit from shadow banks toward regulated banks when the returns to safer projects are depressed. The failure to account for the interaction between regulated banks and shadow banks does not only underestimate the impact of business cycle shocks on Ramsey optimal capital requirements in a range from 10 basis points to 1 percentage point in the U.S., but may also lead to calling for increases in capital requirements when a decrease would otherwise be warranted. I show that capital requirements should also react to shocks that originate in the shadow banking sector even if these shocks do not influence regulated banks directly. The results stress the importance of considering the interactions of regulated banks and shadow banks for designing macroeconomic policies.

The transmission of bank capital requirements and monetary policy to bank lending in Germany

AbstractWe investigate the transmission of changes in bank capital requirements and monetary policy, and their interaction, on German banks’ corporate loan growth and lending rates. Our results show that increases in capital requirements are associated with an immediate decrease in total domestic and cross‐border bank lending. Changes in the euro area's monetary policy stance are positively related to corporate loan interest rates in general. Regarding the interacting effect of national bank capital requirements and euro area monetary policy, we observe that the transmission of accommodative euro area monetary policy to corporate lending rates can be attenuated by contemporaneous increases in bank capital requirements. Moreover, more strongly capitalized banks increase their loan growth in response to accommodative monetary policy whereas, for weaker banks, increasing capital requirements implies a decrease in their corporate loan growth. Our results confirm a tradeoff between higher capital requirements and accommodating monetary policy originating from banks’ capital constraints.

The Transmission of Bank Capital Requirements and Monetary Policy to Bank Lending

We investigate the transmission of changes in bank capital requirements and supranational monetary policy, and their interaction effect, on euro area bank lending and lending rates. Our results show that - for weakly capitalized banks - increases in capital requirements are in the short-run associated with a decrease in the total of domestic and cross-border bank lending. In addition, we find that there is no similar effect of capital requirements for strongly capitalized banks. Furthermore, changes in the monetary policy stance are positively related to lending rates. Regarding the interacting effect of national capital requirements and supranational monetary policy, we observe that increases in capital requirements attenuate the general effects of monetary policy on interest rates. Overall, the transmission of an accommodating monetary policy to lending rates is attenuated by contemporaneous increases in bank capital requirements which additionally imply a transitory decrease of the loan growth of weakly capitalized banks.

Stress tests and small business lending

Post-crisis stress tests have altered banks’ credit supply to small business. Banks most affected by stress tests reallocate credit away from riskier markets and toward safer ones. They also raise interest rates on small loans. Quantities fall most in high-risk markets where stress-tested banks own no branches, and prices rise mainly where they do. The results suggest that banks price the stress-test induced increase in capital requirements where they have local knowledge, and exit where they do not. Stress tests do not, however, reduce aggregate credit. Small banks seem to increase their share in geographies formerly reliant on stress-tested lenders.

The Real Effects of Bank Capital Requirements

We measure the impact of bank capital requirements on corporate borrowing, investment, and employment using loan-level data. The Basel II regulatory framework makes capital requirements vary across both banks and firms, which allows us to control for time-varying firm-level risk and bank-level credit supply shocks. We find that a 1 percentage point increase in capital requirements reduces lending by 2.3%–4.5%. Firms can attenuate this reduction by substituting borrowing across banks, but only to a limited extent. The resulting reduction in borrowing capacity affects significantly both investment and employment: for firms whose effective capital requirements increase by 1 percentage point, fixed assets are reduced by 1.1%, capital expenditures by 2.7%, and employment by 0.8%. This paper was accepted by Tomasz Piskorski, finance.

Monetary Policy, Macroprudential Policy, and Financial Stability

This review reexamines from a theoretical perspective the role of monetary and macroprudential policies in addressing the build-up of risks in the financial system. We construct a stylized general equilibrium model in which the key friction comes from a moral hazard problem in firms’ financing that banks’ equity capital serves to ameliorate. Tight monetary policy is introduced by open market sales of government debt, and tight macroprudential policy by an increase in capital requirements. We show that both policies are useful, but macroprudential policy is more effective in fostering financial stability and leads to higher social welfare.

Bank response to policy-related changes in capital requirements

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.

Monetary Policy, Macroprudential Policy, and Financial Stability

This paper reexamines from a theoretical perspective the role of monetary and macroprudential policies in addressing the build-up of risks in the financial system. We construct a stylized general equilibrium model in which the key friction comes from a moral hazard problem in firms' financing that banks' equity capital serves to ameliorate. Tight monetary policy is introduced by open market sales of government debt, and tight macroprudential policy by an increase in capital requirements. We show that both policies are useful, but macroprudential policy is more effective in terms of financial stability and leads to higher social welfare.

When Losses Turn into Loans: The Cost of Undercapitalized Banks

We provide evidence that a weak banking sector has contributed to low productivity growth following the European sovereign debt crisis. An unexpected increase in capital requirements for a subset of Portuguese banks in 2011 provides a natural experiment to study the effects of reduced bank capital adequacy on productivity. Affected banks respond not only by cutting back on lending but also by reallocating credit to firms in financial distress with prior underreported loan loss provisioning. We develop a method to detect when banks delay loss reporting using detailed loan-level data. We then show that the credit reallocation leads to a reallocation of production factors across firms. A partial equilibrium exercise suggests that the resulting increase in factor misallocation accounts for 20% of the decline in productivity in Portugal in 2012.

Banking System Adjustment to Regulatory Capital Requirements

The main objective of this paper is to explore the adjustment of bank business activities to new regulatory capital requests using panel data analyses of the European banking system. The research hypothesis assumes that the increase in capital requirements affects the banks’ balance sheet adjustment and bank lending to the non-financial sector. The banks can maintain the higher regulatory capital ratio by increasing the volume of share capital or by decreasing the risk-weighted assets and bank lending activities. The high equity premium upon a new equity issue due to asymmetric information about the bank’s net worth discourages the current shareholder to issue additional capital, which has resulted in bank lending constraints and has increased non-risk bank assets. Banks’ response to new capital requirements can announce a long-term negative impact to real economy and bank depending borrowers. The model of empirical analysis of the banking sector adjustment to new capital requirements will be demonstrated on the sample of publicly listed banking firms in the European Union in the period 2000–2016 using dynamic panel-data estimation with the Generalized Method of Moments (GMM) in one-step.

How do Capital Requirements Affect Loan Rates? Evidence from High Volatility Commercial Real Estate

We study how bank loan rates responded to a 50% increase in capital requirements for a subcategory of construction lending, High Volatility Commercial Real Estate (HVCRE). To identify this effect, we exploit variation in the loan terms determining whether a loan is classified as HVCRE and the time that a treated loan would be subject to the increased capital requirements. We estimate that the HVCRE rule increases loan rates by about 40 basis points for HVCRE loans, indicating that a one percentage point increase in required capital raises loan rates by about 9.5 basis points.

How Do Capital Requirements Affect Loan Rates? Evidence From High Volatility Commercial Real Estate

We study how bank loan rates responded to a 50% increase in capital requirements for a subcategory of construction lending, High Volatility Commercial Real Estate (HVCRE). To identify this effect, we exploit variation in the loan terms determining whether a loan is classified as HVCRE and the time that a treated loan would be subject to the increased capital requirements. We estimate that the HVCRE rule increases loan rates by about 40 basis points for HVCRE loans, indicating that a one percentage point increase in required capital raises loan rates by about 9.5 basis points.

Impact of New Regulation on Bank Capital: Analysis of Incremental Risk Charge for Trading Portfolios

This study examines theimpact of the new supervisory standards of Basel 2.5 and Basel III for banktrading portfolios with regards to the additional capital requirements developedto mitigate liquidity risk and credit risk. Using the incremental risk charge(IRC), we estimate risk measures in several alternate contexts. We find apotentially material increase in capital requirements above and beyond thatconcluded in the far-ranging impact studies conducted by the internationalsupervisors. This effect is accentuated for financial or sovereign sectors ascompared to industrial sectors, and regulatory capital is larger than economiccapital. We compare credit risk models and find the multivariate model revealslarger capital estimates for the financial and sovereign sectors by orders ofmagnitude versus the industrial sector or the Basel II model. Finally, in aBayesian experiment we find that the new requirements may introduce addeduncertainty into risk measures as compared to existing approaches.

The Costs and Benefits of Bank Capital Requirements

This paper presents empirical evidence on the impact of changes in capital requirements on bank lending, and delivers estimates of their costs and benefits in terms of foregone real GDP growth. The empirical analysis is based on large international datasets at a firm and country level, including data of the 2007-2009 crisis and beyond. I find that an increase in regulatory capital ratios reduces real GDP growth, with this reduction offsetting its benefits in terms of a reduced probability of a banking crisis. This evidence suggests that the net benefits of an increase in capital requirements may be negligible.