What determines how banks respond to changes in capital requirements?

Working papers set out research in progress by our staff, with the aim of encouraging comments and debate.
Published on 15 April 2016

Working Paper No. 593
By Saleem Bahaj, Jonathan Bridges, Frederic Malherbe and Cian O’Neill 

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.

This version was updated in November 2016.

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