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A positive analysis of bank behaviour under capital requirements

Subject

Economics

Publishing details

CEPR Discussion Paper

Authors / Editors

Bahaj S;Malherbe F

Publication Year

2016

Abstract

We propose a theory of bank behaviour under capital requirements. The sign of the lending response to a change in capital requirement is ambiguous due to the interplay between risk-taking incentives and debt overhang considerations. Optimal lending is typically U-shaped in the capital requirement. Changes in expected returns on loans shift this relationship. The lower expected returns the lower its slope. Using UK regulatory data (1989-2007), we find support for this prediction. It follows that a bank mainly adjusts to a higher capital requirement through cutting lending when expected returns are low, and by raising capital when they are high.

Series

CEPR Discussion Paper

Available on ECCH

No

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