The effects of countercyclical capital buffers on bank lending

Abstract

This article provides a simulation on how the countercyclical capital buffer designed in the Basel III package could impact on bank lending. It finds that the buffer could help to reduce credit growth during booms and attenuate the credit contraction once it is released. This would help to dampen procyclicality in addition to the beneficial effects of higher capital levels in terms of higher banking sector resilience to shocks.

Keywords:

• Basel III
• countercyclical capital buffers
• bank lending
• procyclicality

JEL Classification:

• E44
• E61
• G21

Acknowledgements

We thank Claudio Borio, David Marqués-Ibanez, Gabriel Jimenez, Jesus Saurina, Carlos Trucharte and Kostas Tsatsaronis for useful comments and discussions. The opinions expressed in this article are those of the authors and do not necessarily reflect those of the Bank for International Settlements (BIS).

Notes

¹For the countercyclical capital buffer to have an effect on supplied lending two conditions have to hold. First, the increase in target capital should reduce the excess capital to a level that threatens to breach the minimum capital requirements, generating a cost for the intermediary. Since capital requirements are linked to the amount of credit outstanding, a cut in lending could soft this constraint. By contrast, if the bank has truly excess capital, the drop can be absorbed without any consequence for lending. Second, equity and other sources of funding should be imperfect substitutes, with equity being relatively more costly. This means that banks tend to economize on capital and they do not have too much capital in excess of what the regulator (or the market) requires. It also means that the additional cost will act as a further drag on lending (Cornett and Tehranian, 1994).

² The simulations capture only the effects of the countercyclical capital buffer on bank lending. Angelini et al. (2011) also show that introducing such a countercyclical capital buffer can in general reduce the variability of the output. By using three Dynamic Stochastic General Equilibrium (DSGE) models featuring bank capital (one for the United States and two for the Euro Area) they find that in the case of a technology shock the new countercyclical capital buffer reduces the SD of output relative to the baseline (where no capital buffer is in place) by around 20%.