Capital Requirements, Monetary Policy, and Aggregate Bank Lending: Theory and Empirical Evidence
Capital requirements linked solely to credit risk are shown to increase equilibrium credit rationing and lower aggregate lending. The model predicts that the bank's decision to lend will cause an abnormal run-up in the borrower's stock price and that this reaction will be greater the more capital-constrained the bank. The author provides empirical support for this prediction. The model explains the recent inability of the Federal Reserve to stimulate bank lending by increasing the money supply. He shows that increasing the money supply can either raise or lower lending when capital requirements are linked only to credit risk. Copyright 1996 by American Finance Association.
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Volume (Year): 51 (1996)
Issue (Month): 1 (March)
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