The Effects of Bank Capital and Capital Requirements on Lending

Nicolai Bruun Jørgensen

Student thesis: Master thesis

Abstract

The effect of changes in bank capital on lending is a critical determinant of the relationship between financial conditions and real activity. Quantifying the relationship has therefore been subject to growing attention from researchers, as has the increase in capital requirements in the past decades. The implementation of the Basel III has required banks to hold a higher level of regulatory defined capital to risk-weighted assets which has inspired the question of whether it has affected lending activities in Scandinavia. I use panel regression techniques to study the lending behaviour of Scandinavian banks. As such, solely banks whose primary activity are lending are included. I consider the impact of capital ratios and capital requirements using different regression specifications. First, I find significant – albeit modest – effects of capital ratios on loan growth. However, regardless of the capital ratio I use as the main explanatory variable, the effects of shocks to capital on loan growth are still modest. Moreover, the estimates imply that lending behaviour differ across segments of banks. Second, I find that banks reduce their lending when capital requirements are increased. This is important because it implies that the banking sector changes lending to comply with new capital requirements which can have consequences for the real economy

EducationsMSc in Finance and Investments, (Graduate Programme) Final Thesis
LanguageEnglish
Publication date2020
Number of pages98