New Evidence on Procyclical Bank Capital Regulation: The Role of Bank Loan Commitments

Abstract

Previous research on procyclical bank capital regulation has largely focused on the role of increased loan losses and deteriorated credit ratings in economic downturns. We focus on the role of bank loan commitments, which have been increasingly popular from the 2000s, on the procyclicality of bank capital regulation. Using the bank-level data of U.S. commercial banks, we present another independent source of procyclicality working through bank loan commitments, which we call "loan commitments channel." We find that, as firms draw down more from their pre-existing credit lines when credit market conditions are tighter, this increased takedown raises bank risk-weighted assets via involuntary lending and thus lowers capital adequacy ratios of commercial banks, making them more procyclical. Our empirical results suggest that this loan commitments channel is quantitatively important and needs to be addressed in designing the regulatory framework for reducing credit procyclicality.

Keywords: bank loan commitments, capital adequacy ratio (CAR), procyclical bank capital regulation

JEL Classification: E44, G21, G32