Procyclical Capital Regulation and Lending

Abstract

We combine particular institutional features of the stepwise introduction of asset risk-specific capital charges by German banks with the event of the Lehman shock to test the theory of pro-cyclicality of capital regulation and to quantify the magnitude of this regulation on firms' access to lending. The Lehman shock resulted in an increase of credit risk during the implementation period of the internal ratings-based (IRB) approach to capital regulation. At this point, banks introducing IRB had transferred only a portion of their loan portfolios to the new approach. Exploiting the variation of the regulatory approach within IRB banks and the fact that many firms borrow from several IRB banks at the same time allows us to systematically control for both bank-level and firm-level heterogeneity. Loans to the same firm decline by about 3.5 percent more when the loan is part of an IRB portfolio as compared with a portfolio using the traditional regulatory approach. Since banks tend to reduce especially large IRB credit exposures during the recession, firms relying on IRB loans experience an even stronger reduction in aggregate borrowing (5 to 10 percent larger) as compared with firms relying on loans under the traditional approach. Our findings have important implications for the design of capital regulation (i.e., Basel III).

The contribution of bank regulation and fair value accounting to procyclical leverage

“…Behn et al (2016) find evidence that German bank regulation contributes to procyclical bank lending following the Lehman Brothers bankruptcy in the third quarter of 2008. In particular, they find fewer loans are originated to borrowers by banks with a higher percentage of loans for which the bank determines regulatory risk weights using internal models rather than the fixed risk weights specified by the regulator.…”

CECL and the Credit Cycle

“…Peek and Rosengren 1997) or capital requirements (e.g. Behn et al 2016, Gropp et al 2019). In addition, many use borrower level data to further control for borrower-specific credit demand.…”

Time-Varying Capital Requirements and Disclosure Rules: Effects on Capitalization and Lending Decisions

“…Behn et al (2016). This creates large variation in banks' capital structure and we account for this via a dummy variable which is one in the period when the IRB models are introduced by the bank.…”

“…the level of capital, prior literature suggests that banks rather adjust it using the components of its denominator, i.e. the amount or riskiness of loans and other exposures (e.g., Aiyar et al, 2014Aiyar et al, , 2016Acharya and Steffen, 2015;Behn et al 2016;De Jonghe et al, 2016). The table confirms that banks adjust their capital ratio by adjusting the components of its denominator.…”