Caution: Do Not Cross! Distance to Regulatory Capital Buffers and Lending in Covid-19 Times

Event Date: 20 October 2021

Speaker: Alessio Reghezza, Bangor Business School

Time: 2pm  (Zoom details emailed to faculty the week prior, otherwise please email donna.irving@strath.ac.uk)

Abstract:

While regulatory capital buffers are expected to be drawn to absorb losses and meet credit demand during crises, this paper provides empirical evidence that banks did not show any intention to use such buffers during the severe recession caused by the COVID-19 pandemic. To the contrary, banks engaged in forms of pro-cyclical behaviour to preserve capital ratios. By employing euro area bank level and credit register data, we isolate credit supply effects and find that banks with little headroom above regulatory requirements contracted their credit supply relative to other banks, also when controlling for a broad range of pandemic policy support measures. This resulted in credit constraints for firms exposed to banks with a smaller capital headroom as lost loans were not  replaced by other banks. We also find that state guarantee schemes had a positive effect in mitigating banks' reaction to capital constraints. These findings contribute to the current debate on the effectiveness of the capital buffer framework and support discussions on how to improve its design. They also shed some light on the fiscal and prudential policies' interactions which took place during the pandemic.

Published: 19 October 2021