The Effects of Bank Capital on Lending: What Do We Know, and What Does It Mean?
by Jose M. Berrospide and Rochelle M. Edge
Federal Reserve Board
The effect of bank capital on lending is a critical determinant
of the linkage between financial conditions and real activity,
and has received especial attention in the recent financial
crisis. We use panel regression techniques—following Bernanke
and Lown (1991) and Hancock and Wilcox (1993, 1994)—to
study the lending of large bank holding companies (BHCs) and
find small effects of capital on lending. We then consider the
effect of capital ratios on lending using a variant of Lown and
Morgan’s (2006) VAR model, and again find modest effects
of bank capital ratio changes on lending. These results are in
marked contrast to estimates obtained using simple empirical
relations between aggregate commercial bank assets and leverage
growth, which have recently been very influential in shaping
forecasters’ and policymakers’ views regarding the effects
of bank capital on loan growth. Our estimated models are
then used to understand recent developments in bank lending
and, in particular, to consider the role of TARP-related
capital injections in affecting these developments.
JEL Codes: E51, G010, G21, G28, G32.
(PDF, 50 pages 908 kb)
Discussion by José-Luis Peydró