Effects of Equity Capital on the Interest Rate and the Demand for Credit: Empirical Evidence from Spanish Banks

36 Pages Posted: 28 Apr 2012

See all articles by Alfredo Martín‐Oliver

Alfredo Martín‐Oliver

University of the Balearic Islands

Sonia Ruano

Banco de España

Vicente Salas-Fumás

University of Zaragoza - Department of Business Administration and Organization

Date Written: April 27, 2012

Abstract

We examine the consequences of imposing higher capital requirements on banks (as under Basel III or, recently, in the case of large banks in the European context) for bank dynamics in complying with the new standards and for the long-term effects on bank lending rates and the demand for bank credit. The analysis combines econometric estimations of the determinants of equity capital ratios and lending rates with simulations of market equilibrium results for loan interest rates and the demand for bank credit, based on a parameterised model of the Spanish banking industry. We find that the gap between the target and the actual capital ratio is reduced by around 40% every year, mainly with retained earnings. We also find that raising the equity capital ratio by one percentage point increases bank lending rates by 4.2 basis points. Finally, the simulation exercise shows that the estimated increase in the cost of funds for banks associated with a one percentage point increase in the equity capital ratio leads to a fall of 0.8% in the total demand for bank credit. These results suggest that the social costs of higher equity capital requirements for banks are expected to be greater in the transition period, when banks are adjusting to the new standards, than in the steady state of the new industry equilibrium, when all banks comply with the new ratio.

Keywords: Bank capital regulation, Basel III, bank lending rates, demand for credit

JEL Classification: D24, G21

Suggested Citation

Martin-Oliver, Alfredo and Ruano, Sonia and Salas-Fumás, Vicente, Effects of Equity Capital on the Interest Rate and the Demand for Credit: Empirical Evidence from Spanish Banks (April 27, 2012). Banco de Espana Working Paper No. 1218, Available at SSRN: https://ssrn.com/abstract=2046923 or http://dx.doi.org/10.2139/ssrn.2046923

Alfredo Martin-Oliver (Contact Author)

University of the Balearic Islands ( email )

Crtra. Valldemossa, km 7.5
Ed. Jovellanos
Palma de Mallorca, Illles Balears 07122
Spain

Sonia Ruano

Banco de España ( email )

Madrid 28014
Spain

Vicente Salas-Fumás

University of Zaragoza - Department of Business Administration and Organization ( email )

Dr. Cerrada 1
5005 Zaragoza
Spain
+34 976 761803 (Phone)

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