What Determines How Banks Respond to Changes in Capital Requirements?

38 Pages Posted: 20 Apr 2016

See all articles by Saleem Bahaj

Saleem Bahaj

Bank of England

Jonathan Bridges

Bank of England

Frederic Malherbe

University College London - Department of Economics

Cian O'Neill

Bank of England

Date Written: April 15, 2016

Abstract

Legacy asset overhang and incentive to shift risk due to government guarantees can both affect bank capital issuance and lending decisions. We show that such frictions lead to ambiguous predictions on how one should expect a bank to react to a change in capital requirements. One sustained prediction is that lending is less sensitive to a change in capital requirements when lending prospects are good and legacy assets are healthy. Using UK bank regulatory data from 1989 to 2007, we find strong empirical support for this prediction.

Keywords: Debt overhang, risk-shifting, bank capital, local projections

JEL Classification: G21, G32

Suggested Citation

Bahaj, Saleem and Bridges, Jonathan and Malherbe, Frederic and O'Neill, Cian, What Determines How Banks Respond to Changes in Capital Requirements? (April 15, 2016). Bank of England Working Paper No. 593, Available at SSRN: https://ssrn.com/abstract=2766374 or http://dx.doi.org/10.2139/ssrn.2766374

Saleem Bahaj (Contact Author)

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

Jonathan Bridges

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

Frederic Malherbe

University College London - Department of Economics ( email )

Drayton House, 30 Gordon Street
30 Gordon Street
London, WC1H 0AX
United Kingdom

Cian O'Neill

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

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