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COVID-19 Crisis, Prudential Policy, and Bank Lending

Paper Session

Friday, Jan. 6, 2023 8:00 AM - 10:00 AM (CST)

Hilton Riverside, Jackson
Hosted By: American Economic Association
  • Chair: Aakriti Mathur, Bank of England

Useful, Usable, and Used? Buffer Usability During The COVID-19 Crisis

Aakriti Mathur
,
Bank of England
Matthew Naylor
,
Bank of England
Aniruddha Rajan
,
Bank of England

Abstract

Using regulatory data on 159 UK banks we assess whether regulatory capital buffers, introduced in 2016 as part of the Basel III package of reforms, disincentivised banks from supporting lending through the Covid-19 crisis. Using a difference-in-differences econometric strategy, we compare capital and lending outcomes between banks with pre-pandemic common equity capital ratios (CET1 ratios) close to the threshold for regulatory buffers (i.e. low surplus banks) and those further away (i.e. high surplus banks). We find some evidence that low surplus banks provided less non government guaranteed UK corporate lending compared to their peers, but do not find similar effects for UK mortgage lending. However, evidence from granular loan-level data on UK residential mortgages indicates that low surplus banks did reduce the size of mortgage loans they supplied and reduced their risk taking (by reducing loan-to-value ratios) as compared to high surplus banks. We also find some evidence for the value of releasable buffers in promoting buffer usability. Banks that benefitted more from cuts in regulatory buffers at the onset of the pandemic grew their CET1 ratios by less than their peers. However, this did not result in greater domestic lending provision by these banks.

How to Release Capital Requirements During a Pandemic? Evidence From Euro Area Banks

Cyril Couaillier
,
European Central Bank
Alessio Reghezza
,
European Central Bank, Bangor University, and University of Genoa
Costanza Rodriguez d’Acri
,
European Central Bank
Alessandro Scopelliti
,
KU Leuven and University of Zurich

Abstract

This paper investigates the impact of the capital relief package adopted to support European banks at the outbreak of the COVID-19 pandemic. By leveraging confidential supervisory and credit register data, we uncover two main findings. First, capital relief measures support banks’ capacity to supply credit to firms. Second, not all measures are equally successful. Banks adjust their credit supply only if the capital relief is permanent or implemented through established processes. By contrast, discretionary relief measures are met with limited success, possibly owing to the uncertainty surrounding their capital replenishment path. Moreover, requirement releases are more effective for banks with a low capital headroom over requirements and do not trigger additional risk-taking. These findings provide key insights on how to design effective bank capital requirement releases in crisis time.

Caution: Do Not Cross! Capital Buffers and Lending in COVID-19 Times

Cyril Couaillier
,
European Central Bank
Marco Lo Duca
,
European Central Bank
Alessio Reghezza
,
European Central Bank, Bangor University, and University of Genoa
Costanza Rodriguez d’Acri
,
European Central Bank

Abstract

While regulatory capital buffers are expected to be drawn to absorb losses and meet credit demand during crises, this paper shows that banks were unwilling to do so during the pandemic. To the contrary, banks engaged in forms of pro-cyclical behaviour to preserve capital ratios. By employing granular data from the credit register of the European System of Central Banks, we isolate credit supply effects and find that banks with little headroom above regulatory buffers reduced their lending relative to other banks, also when controlling for a broad range of pandemic support measures. Firms’ inability to reallocate their credit needs to less constrained banks had real economic effects, as their headcount went down, although state guarantee schemes acted as partial mitigants. These findings point to some unintended effects of the capital framework which may create incentives for pro-cyclical behaviour by banks during downturns. They also shed light on the interactions between fiscal and prudential policies which took place during the pandemic.

Usability of Bank Capital Buffers: The Role of Market Expectations

José Abad
,
International Monetary Fund
Antonio Garcia Pascual
,
International Monetary Fund

Abstract

Following the COVID shock, supervisors encouraged banks to use capital buffers to support the recovery. However, banks have been reluctant to do so. Provided the market expects a bank to rebuild its buffers, any draw-down will open up a capital shortfall that will weigh on its share price. Therefore, a bank will only decide to use its buffers if the value creation from a larger loan book offsets the costs associated with a capital shortfall. Using market expectations, we calibrate a framework for assessing the usability of buffers. Our results suggest that the cases in which the use of buffers make economic sense are rare in practice.

Discussant(s)
Sebastian Doerr
,
Bank for International Settlements
Steven Ongena
,
University of Zurich, SFI, KU Leuven, NTNU Business School and CEPR
Diana Bonfim
,
Bank of Portugal and Catholic University of Portugal
Gazi Kabas
,
University of Zurich and Tilburg University
JEL Classifications
  • G2 - Financial Institutions and Services