EBA capital exercise cut euro area loan growth by 1.6 percent
A Banque de France working paper finds that the EBA's 2011/12 Capital Exercise reduced euro area loan growth by 1.2 to 1.6 percentage points. Banks required to increase capital showed significantly lower lending over the nine-month period.
Capital shortfall curbed lending
The study exploits the European Banking Authority's 2011/12 Capital Exercise as a natural experiment to assess the capital-lending relationship.
Announced in October 2011, the exercise required large European banking groups to meet a higher Tier 1 capital ratio by June 2012, including a temporary buffer against sovereign debt exposure.
Researchers found that banks in groups needing to increase capital by 1 percent of risk-weighted assets experienced annualized loan growth 1.2 to 1.6 percentage points lower over the nine-month period than unconstrained banks.
This effect was observed across a unique monthly dataset of bank balance sheets, covering some 250 large individual banks in the euro area, controlling for bank characteristics and country-level demand.
No substitution for constrained lenders
The EBA's Capital Exercise, announced in October 2011, aimed to reassure markets during the euro area sovereign debt crisis.
It required large European banking groups to meet a higher Tier 1 capital ratio by June 2012, including a temporary buffer against sovereign debt exposure.
The study found that banks not constrained to recapitalize did not substitute for those that had to increase their capital ratios.
This suggests the exercise had procyclical macroeconomic effects on credit supply.
The authors also established that information released during the exercise did not cause large changes in banks' CDS spreads, ruling out increased funding stress as the primary cause for reduced lending.
Procyclical impact confirmed
This research provides crucial empirical evidence on the contentious debate surrounding capital requirements and lending, confirming the procyclical impact of the EBA's exercise.
The contained magnitude of credit contraction, coupled with the lack of substitution by unconstrained banks, highlights systemic implications for overall credit supply.
These findings remain highly relevant for future supervisory decisions, particularly for the European Single Supervisor's Asset Quality Review.