The Macroeconomic Impact of Bank Capital Requirements in Emerging Economies: Past Evidence to Assess the Future

Abstract

We test for emerging economies the hypothesis — previously verified for G-10 countries only — that the enforcement of bank capital asset requirements (CARs) exerts a detrimental effect on the supply of credit. The econometric analysis on individual bank data suggests three main results. First, CAR enforcement — according to the 1988 Basel standard — significantly curtailed credit supply, particularly at less-well capitalized banks. Second, such negative impact was larger for countries enforcing CARs in the aftermath of a currency/financial crisis. Third, the adverse impact of CARs on the credit supply was significantly smaller for foreign-owned banks, suggesting that opening up to foreign investors may be an effective way to partly shield the domestic banking sector from negative shocks. Overall, CAR enforcement — by inducing banks to reduce their lending — may well have induced an aggregate credit slowdown or contraction in the examined emerging countries. This paper is relevant to the ongoing debate on the impact of the revision of bank CARs, as contemplated by the 1999 Basel proposal. Our results suggest that in several emerging economies the revision of bank CARs could well induce a credit supply retrenchment, which should not be underestimated.

Keywords: bank capital asset requirements, capital crunch

JEL Classification: G18, G21, G28