A positive analysis of bank behaviour under capital requirements

Frederic Malherbe and Saleem Bahaj

No 11607, CEPR Discussion Papers from C.E.P.R. Discussion Papers

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.

JEL-codes: G21 G28 (search for similar items in EconPapers)
Date: 2016-11
New Economics Papers: this item is included in nep-ban, nep-cba, nep-cfn and nep-rmg
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Citations: View citations in EconPapers (17)

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