The macroeconomic impact of changes in economic bank capital buffers

How do changes in bank capital requirements affect bank lending, lending spreads and the broader macroeconomy? The answer to this question is important for calibrating and assessing macroprudential policies. There is, however, relatively little empirical evidence to answer this question in the case of the euro area countries. This article contributes to filling this gap by studying the effects of changes in economic bank capital buffers in the four largest euro area countries. We use bank-level data and macroeconomic information to estimate a bank-internal, target level of economic capital ratio, i.e. the capital ratio that a bank would like to hold considering its own characteristics (size, profitability, risk aversion of its creditors, risk exposure, etc.) and macroeconomic conditions (expected GDP growth, etc.). Economic bank capital buffers are then computed as the difference between the current and the target economic capital ratio. However, due to adjustment costs, banks cannot adjust the actual capital ratio to the target level instantaneously. As a result, a change in the target capital ratio will result in an instantaneous change in the economic capital buffer. These buffers are aggregated at the country level and included in a panel Bayesian vector auto regressive (VAR) model. With the VAR, it is then possible to compute the response of macroeconomic and banking variables to a change in the buffer. The idea is that changes in economic capital buffers mimic the effects a change in regulatory capital requirements would have on the economy. We find that a negative economic capital buffer shock, i.e. a decline in actual capital ratios below the target level, leads to a modest decline in output and prices and to a larger decline in bank lending growth. By affecting the difference between actual and target economic capital ratios, these findings suggest that countercyclical capital-based macroprudential policy measures can be useful to dampen the financial cycle. JEL Classification: C11, E58, G21