Bank Response to Policy Related Changes in Capital Requirements

This paper uncovers current, and estimates future, responses by banks which are under notification of increased capital requirements. We collect notifications on regulatory capital requirements sent to Slovenian banks in the period 2009-2015 and construct a forward-looking measure of capital surplus/shortfall. Using a differences-in-differences model we show that the same firm has on average a 3.54 p.p. lower loan growth when the loan is obtained through a bank with 1 p.p. higher capital shortfall. Once the capital surplus/shortfall is included in the regression model, the coefficient on the capital adequacy ratio, often used as the main policy variable in empirical literature, becomes insignificant. It is insignificant because surplus/shortfall is a forward-looking measure of bank capitalization and conveys more information about future lending. Finally, we show that in response to an increase in capital requirements banks engage in more risk-taking behaviour. Our paper carries policy implications for regulators in countries with distressed banking sector.