Bank capital costs still hit corporate lending
A Bank of England analysis confirms higher bank capital requirements increase corporate lending spreads. The updated study finds these costs are primarily passed on to businesses, not households.
Corporate lending bears the burden
The Bank of England's updated analysis, covering over 30 years of data through 2024, reinforces earlier findings on the economic cost of bank capital.
Despite significant changes in the UK banking system, including post-crisis reforms and the COVID-19 pandemic, the central findings remain robust.
Banks continue to pass the cost of higher capital predominantly to corporate borrowers.
Updated estimates suggest pass-through rates of around 7 to 10 basis points on corporate lending spreads for every 1 percentage point increase in capital ratios.
This is broadly consistent with previous estimates of 10 to 12 basis points.
The long-run relationship between risk-based capital ratios and mortgage spreads remains statistically insignificant, mirroring the 2017 findings.
Corporate spreads adjust more quickly towards equilibrium than mortgage spreads, reflecting banks' focus on higher risk-weighted lending when managing capital.
Why capital affects lending
Banks finance lending using a mix of deposits, wholesale funding, and equity capital.
When capital requirements rise, banks typically adjust their balance sheets to maintain a voluntary buffer above the minimum.
This involves actions such as raising more capital, shrinking assets, or altering the pricing and composition of lending.
Corporate loans, being riskier and often shorter-term compared to household mortgages, attract higher regulatory risk-weights.
Consequently, banks tend to adjust corporate lending spreads more readily when optimizing their capital position.
This mechanism underpins the 'corporate lending channel', through which prudential capital policy influences the real economy.
Extending the model to include updated measures of banking sector competition, such as the Lerner index, does not materially alter these central results, confirming the concentration of pass-through in corporate lending spreads.
Robust findings, clear implications
The evidence consistently points to modest, but non-zero, economic costs of capital, concentrated in corporate lending.
This stability provides a reliable, evidence-based benchmark for assessing capital costs in the Prudential Regulation Authority's cost-benefit analysis.
The updated findings affirm the PRA's approach to weighing the costs and benefits of capital requirements, supporting its judgments on appropriate capital levels and risk weights for banks.