Capital Requirements and Banks' Leniency

J. Kimball Dietrich, Clas Wihlborg

Research output: Working paperResearch

Abstract

We investigate the effect of changes in capital regulation on the strictness(leniency) of loan terms using a simple model of bank capital requirements andasset quality examinations. Banks offer different levels of `leniency' in the senseof willingness to offer automatic extensions of loans in the presence of temporarypayment difficulties of borrowers. Banks offering lenient (less strict) loan termsmust have higher initial levels of capital and charge higher loan rates. Whencapital requirements are increased, both strict and lenient banks hold higher levelsof initial capital and they raise loan rates. As capital requirements increase thedifference between initial capital levels and between interest rates of strict andlenient banks decrease. Thus, higher capital requirements in recessions tend toreduce the interest rate premium paid for leniency. If a recession is interpreted asan increase in the required return, the interest rate premium paid for leniency isincreased in recession at a given level of required capital.
We investigate the effect of changes in capital regulation on the strictness(leniency) of loan terms using a simple model of bank capital requirements andasset quality examinations. Banks offer different levels of `leniency' in the senseof willingness to offer automatic extensions of loans in the presence of temporarypayment difficulties of borrowers. Banks offering lenient (less strict) loan termsmust have higher initial levels of capital and charge higher loan rates. Whencapital requirements are increased, both strict and lenient banks hold higher levelsof initial capital and they raise loan rates. As capital requirements increase thedifference between initial capital levels and between interest rates of strict andlenient banks decrease. Thus, higher capital requirements in recessions tend toreduce the interest rate premium paid for leniency. If a recession is interpreted asan increase in the required return, the interest rate premium paid for leniency isincreased in recession at a given level of required capital.
LanguageEnglish
Place of PublicationKøbenhavn
Number of pages29
ISBN (Electronic)x656312717
StatePublished - 2003

Keywords

    Cite this

    Dietrich, J. K., & Wihlborg, C. (2003). Capital Requirements and Banks' Leniency. København.
    Dietrich, J. Kimball ; Wihlborg, Clas. / Capital Requirements and Banks' Leniency. København, 2003.
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    Dietrich, JK & Wihlborg, C 2003 'Capital Requirements and Banks' Leniency' København.

    Capital Requirements and Banks' Leniency. / Dietrich, J. Kimball; Wihlborg, Clas.

    København, 2003.

    Research output: Working paperResearch

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    Dietrich JK, Wihlborg C. Capital Requirements and Banks' Leniency. København. 2003.