The Impact of Capital Requirements on Bank Lending Behavior

Abstract

In this paper, we investigate if stricter capital requirements have a significant impact on bank lending to European households and corporations. The Basel III accords tightened Tier 1 capital and Common Equity Tier 1 (CET1) capital requirements. These requirements must be at least 4.5% and 6% respectively, of risk-weighted assets. We study if Tier 1 capital affect corporate lending and household lending. We have built a data set on European Central Bank (ECB) bank data, which we use to run regressions on lending to households and corporations in Europe. Tier 1 capital ratio and Common Equity Tier 1 ratio both increase household lending when capital requirements tighten. However, when estimating the effect of the two capital requirements on the ratio of growth in loans to households relative to growth in loans to corporations, the results have the opposite effect. Stricter Tier 1 capital requirements suggest that banks substitute towards corporate lending. On the opposite side, an increase in Common Equity Tier 1 suggest that banks substitute towards household lending.