The Impact of Strengthened Basel III Banking Regulation on Lending Spreads: Comparisons across Countries and Business Models

We estimate required increase in banks' lending spreads assuming that banks would raise lending spreads among the measures they could take to prevent ROE from falling when the capital regulation is tightened following the estimation methodology employed by King (2010) or Elliott (2010). Major factors affecting the lending spreads are the ratio of RWA to total assets, the relative size of loan to total assets or the long term interest rate on debt, ceteris paribus. The estimation results show that required lending spreads vary greatly across the banks of various business models or country by country. We find that the required lending spreads to keep ROE from falling vary from 0.1 basis points for real estate & mortgage banks to 9.1 basis points for commercial banks over the sample periods of 2005~2010 while it decreases after the 2007~2008 global financial crisis. Countries such as Brazil, China, India, and Mexico require the banks to have large lending spreads ranging from 13.2 basis points to 29.7 basis points. On the other hand, countries such as Australia, Switzerland, Germany, Italy, and Netherland require them to increase smaller lending spreads for the increase in the regulatory capital. Apart from the capital regulation, we find that liquidity regulation (NSFR) increases lending rates by 20.0 basis points for the commercial banks of the sample countries.