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Pro-Cyclical Capital Regulation and Lending

The Journal of Finance, Vol. 71, Issue 2, pp. 919-956

Authors:
Markus Behn,
Rainer Haselmann,
Paul Wachtel
Research Area:
Financial Intermediation
Date:
Apr 2016
Keywords:
capital regulation, credit crunch, financial crisis, pro-cyclicality
Abstract:

We use a quasi-experimental research design to examine the effect of model-based capital regulation on the pro-cyclicality of bank lending and firms' access to funds. In response to an exogenous shock to credit risk in the German economy, capital charges for loans under model-based regulation increased by 0.5 percentage points. As a consequence, banks reduced these loans by 2.1 to 3.9 percentage points more than loans under the traditional approach with fixed capital charges. We find an even stronger effect when we examine aggregate firm borrowing, suggesting that micro-prudential capital regulation can have sizeable real effects.

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