The Impact of Basel III Capital Regulation on Bank Lending

This paper revisits the question of the effects of bank capital requirements on bank lending from the perspective of the U.S. economy’s experience in implementing the capital-reform component of Basel III. We use the announcement of proposed Basel III rules in June 2012, and the publication of the final rules in July 2013 as two events containing some regulatory elements that were new. We exploit the new and unexpected elements in the new capital reform and define the regulatory surprise using the proposed rules as the difference between Basel III capital ratios under the new rules and existing Basel I capital ratios. We also study the impact of the final rules relative to the proposed rules using the regulatory surprise defined as the difference between Basel III capital ratios under the final rules and the Basel III capital rules under the proposed rules. We examine the effects of the equity capital ratio and the two changes in BHC regulatory capital on bank lending, first using BHC-level loan-volume data for all of the 900 BHCs subject to Basel III and then using C&I loan-level data, collected as part of the Federal Reserve’s stress tests for the largest U.S. BHCs. We find a positive but relatively small impact of capital for the average U.S. BHC subject to the Basel III proposed rules. We find a larger impact of capital after we control for loan demand using a lender-borrower matched sample for the largest BHCs. Our estimates suggest that a 1 percentage point increase in equity capital increases 4-quarter C&I loan growth between 10 and 15 percentage points. We find a negative and significant effect of the regulatory surprise on loan growth. The average effect seems also small in the sample of 900 BHCs but considerably larger for the largest BHCs (between 4 and 7 percentage points). However, this large negative effect is not sufficient to offset the positive effect of the capital ratio on C&I loan growth. We interpret this result as suggesting that the largest U.S. BHC are relatively well-positioned to absorb the impact of the Basel III regulation. However, our findings indicate that the effect of capital and the regulatory surprise reduced considerably after the final rules were announced in July 2013, suggesting that the size of these effects vary substantially over time.