(When) Do Banks React to Anticipated Capital Reliefs?

Abstract

We study how banks react to policy announcements during the representative policy cycle of consultation and policy publication. We use unique data covering the population of all mortgage transactions in the UK complemented with regulatory risk assessments of banks and their supervisory interactions. We show that banks likely to benefit from lower capital requirements increase the size of this capital relief by permanently investing into low-risk assets after the publication of the policy. Within this group, those banks with a higher frequency of supervisory interactions already react to the first step of policy development, the publication consultation. We show how these results can be used to estimate a lower bound on the cost of capital for smaller banks, for which such estimates are typically difficult to obtain.

Keywords: Bank Regulation, Mortgage Lending, Supervisory Review Process, Capital Requirements