Does Macro-Prudential Regulation Leak? Evidence from a UK Policy Experiment

The regulation of bank capital as a means of smoothing the credit cycle is a central element of forthcoming macro-prudential regimes internationally. For such regulation to be effective in controlling the aggregate supply of credit it must be the case that: (i) changes in capital requirements affect...

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Bibliographic Details
Published in:Journal of money, credit and banking credit and banking, 2014-02, Vol.46 (s1), p.181-214
Main Authors: AIYAR, SHEKHAR, CALOMIRIS, CHARLES W., WIELADEK, TOMASZ
Format: Article
Language:English
Subjects:
Bank assets
Bank capital
Bank credit
bank lending
Bank loans
Bank regulation
Banking regulation
Banks
Capital needs
Capital requirements
Credit
Credit control
credit cycles
E32
E51
Economic regulation
F30
Financial regulation
Foreign subsidiaries
G21
G28
instrumental variables
Loans
macro-prudential regulation
Macroprudential regulation
Regulation of financial institutions
regulatory arbitrage
Studies
Subsidiary
transmission mechanism
United Kingdom
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Summary:The regulation of bank capital as a means of smoothing the credit cycle is a central element of forthcoming macro-prudential regimes internationally. For such regulation to be effective in controlling the aggregate supply of credit it must be the case that: (i) changes in capital requirements affect loan supply by regulated banks, and (ii) unregulated substitute sources of credit are unable to offset changes in credit supply by affected banks. This paper examines micro evidence—lacking to date—on both questions, using a unique data set. In the UK, regulators have imposed time-varying, bank-specific minimum capital requirements since Basel I. It is found that regulated banks (UK-owned banks and resident foreign subsidiaries) reduce lending in response to tighter capital requirements. But unregulated banks (resident foreign branches) increase lending in response to tighter capital requirements on a relevant reference group of regulated banks. This "leakage" is substantial, amounting to about one-third of the initial impulse from the regulatory change.
ISSN:0022-2879
1538-4616
DOI:10.1111/jmcb.12086