Bank's Capital Buffers and Business Cycle: Evidence from GCC Countries. 2004-2011

This paper empirically investigates the relationship between the capital buffers maintained by banks and the business cycle in a panel covering 70 banks drawn from all six GCC countries during the period 2004-2011. We estimate a standard partial adjustment model accounting for GDP per capita growth, the chosen measure of economy-wide business cycle, and a set of control variables using dynamic GMM panel estimation. We find banks’ capital buffers and the business cycle to be robustly and negatively associated. However, we also find this evidence to be stronger for the case of large banks where the access to capital equity markets and public support is likely to constitute a strong incentive to increase credit exposure and lower capital bases accordingly. On the other hand, for small banks, the negative effect was attenuated by their small size, which could be explained by their limited access to equity markets and the difficulty they face in re-building their capital bases during economic recessions. Not surprisingly, therefore, our finding coheres with the observation that small banks are more likely to adopt more conservative practices where capital buffers are less responsive to short run changes of the business cycle.