Capital ratios drive differentiated deleveraging in EU banks
A new DNB working paper reveals that higher capital ratios lead to differentiated deleveraging among large European banks. This effect is more pronounced for high-risk portfolios and banks with low leverage ratios, while higher capital requirements cause only a small increase in loan rates.
Capital ratios drive portfolio adjustments
The study establishes a pattern of differentiated deleveraging where higher capital ratios are associated with smaller portfolio sizes.
This reduction is systematically larger for portfolios with higher average risk-weights and for banks with lower leverage ratios.
Furthermore, reductions in portfolio size are more pronounced for risk-weighted assets than for unweighted exposures.
In contrast, time-varying capital requirements show little additional explanatory power for portfolio volumes once capital ratios are controlled for.
On the pricing side, higher capital requirements are associated with a small increase in portfolio loan rates, estimated at about 9 basis points for a 1 percentage point increase in the capital requirement for new lending.
This finding is in the mid-range of previous empirical estimates.
Unpacking bank balance sheets
The empirical analysis uses data on portfolios and bank characteristics for a sample of large European banks from 2014-2025.
Researchers combined portfolio-level data and capital ratios from EBA Transparency Exercises with hand-collected bank-specific capital requirements.
The study employs dynamic panel data models with heterogeneous slope coefficients to analyze how banks adjust their balance sheets in response to capital ratios and requirements.
This approach allows for varied responses across portfolios and banks, moving beyond single-country or aggregate lending studies to provide cross-country estimates for a detailed portfolio-level dataset under the current policy regime.
Requirements absorbed, not transmitted
The paper's finding that capital requirement increases are largely absorbed by lower headroom, rather than higher capital ratios, is a crucial insight for regulators.
It suggests that once banks are adequately capitalized, capital requirements can be varied without causing substantial changes in bank loan supply and pricing.
However, the caveat that requirements are measured at implementation or announcement dates leaves open the possibility of stronger behavioral effects in the interim.
This nuanced pass-through underscores the complexity of regulatory impact on bank behavior.