Effects of equity capital on the interest rate and the demand for credit. Empirical evidence from Spanish banks

Alfredo Martin-Oliver, Sonia Ruano () and Vicente Salas-Fumás
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Sonia Ruano: Banco de España
Vicente Salas-Fumás: Universidad de Zaragoza

No 1218, Working Papers from Banco de España

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 (search for similar items in EconPapers)
JEL-codes: D24 G21 (search for similar items in EconPapers)
Pages: 36 pages
Date: 2012-04
New Economics Papers: this item is included in nep-ban, nep-cba and nep-cmp
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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Persistent link: https://EconPapers.repec.org/RePEc:bde:wpaper:1218

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