Do Better Capitalized Banks Lend Less? Long‐Run Panel Evidence from Germany

• Published date: 01 March 2014
• Author: Claudia M. Buch,Esteban Prieto
• Date: 01 March 2014
• DOI: http://doi.org/10.1111/infi.12041

Do Better Capitalized Banks

Lend Less? Long‐Run Panel

Evidence from Germany

Claudia M. Buch

y

and Esteban Prieto

z

y

IWH, University of Magdeburg, and CESifo, and

z

Deutsche Bundesbank

Abstract

Higher capital features prominently in proposals for regulatory reform.

But how does increased bank capital affect business loans? The real costs

of increased bank capital in terms of reduced loans are widely believed

to be substantial. But the negative real‐sector implications need not be

severe. In this pape r, we take a long‐run perspective by analysing the

link between the capitalization of the banking sector and bank loans

using panel cointegration models. We study the evolution of the German

economy for the past 44 years. Higher bank capital tends to be associat-

ed with higher business loan volume , and we find no evidence for a

negative effect. This result holds both for pooled regressions as well as

for the individual banking groups in Germany.

We thank two anonymous referees, Jörg Bre itung, Mathias Hoffman n, Jörn Kleinert, Luk as

Menkhoff, Jörg Rochol la nd seminar participants at the uni versities of Zürich and Hannover

and at the CESifo Area Conference on Macro, Money and International Finance

(March 2012) for most hel pful comments and discussions. The vi ews expressed in this paper

do not necessarily reflect the views of the Deutsche Bundesbank. All er rors and inconsisten-

cies are solely our own re sponsibility.

International Finance 17:1, 2014: pp. 1–23

DOI: 10.1111/infi.12041

© 2014 John Wiley & Sons Ltd

I. Motivation

Insufficient bank capital buffers have been identified as one main cause of

the large systemic effects in the recent financial crisis. Although higher

capital requirements are no panacea, they feature prominently in proposals

for regulatory reform.

1

We study how increased bank capital affects bank

loans. If the Modigliani–Miller theorem applies to banks, then the funding

structure of banks would be irrelevant for the volume and structure of banks’

activities (Miller 1995). Yet there is widespread belief that bank loans decline

in the short run when banks need to hold more capital. In the long run though,

the negative real‐sector implications need not be severe (Kashyap et al. 2010;

Admati et al. 2011). In order to meet increased capital requirements, banks can

shrink their balance sheets, they can recapitalize and keep assets constant, or

they can even expand their assets. In addition, they can change the structure of

their assets by increasing or decreasing the share of business loans.

We analyse the link between bank capital and bank loans in the long run

using panel evidence for German banking groups over the last 44 years

(1965–2009). The German banking system provides an interesting case study

for two reasons. First, we can study heterogeneity across different banking

groups. Typically, the German banking sector is analysed along the three

main pillars: the private commercial banks, the publicly owned savings banks

and the cooperative banks. However, even within the pillar of the publicly

owned banks there is substantial heterogeneity. The savings banks have a

strong regional focus and have, in the period under study, not operated in

international capital markets. The Landesbanken, which are also part of the

publicly owned banking sector, have a different business model and have,

especially in recent decades, inves ted via international capital markets quite

extensively. Our data allow us to account for such differences by breaking the

data into nine distinct banking groups.

The banking groups differ with regard to their business model and the

institutional framework in which they operate. We can use this heterogeneity

across banking groups to identify the impact of capital on loans. Hence, our

panel data allow us to combine the advantages of exploiting heterogeneity

across banks with the ability to study long‐run adjustment patterns in the data.

Second, German banks are important lenders on international banking

markets, holding over 6% of cross‐border assets of all banks reporting to the

Bank for International Settlements prior to the financial crisis at the end of

2006. Almost one‐half of German banks’foreign assets are held in the euro

1

Higher capital requi rements are a core feature of the Basel III framework ( Basel Committee

on Banking Supervision 2011) and feature prominently in reform proposals such as the one

proposed by the Indepe ndent Commission on B anking (2011) in the Unite d Kingdom.

2Claudia M. Buch and Esteban Prieto

© 2014 John Wiley & Sons Ltd