| Abstract: |
What kinds of credit substitution, if any, occur when changes to banks’
minimum capital requirements induce banks to change their supply of credit?
The question is central to the new ‘macroprudential’ policy regimes that have
been constructed in the wake of the global financial crisis, under which
minimum capital ratio requirements for banks will be employed to control the
supply of bank credit. Regulatory efforts to influence the aggregate supply of
credit may be thwarted to some degree by ‘leakages’, as other credit suppliers
substitute for the variation induced in the supply of credit by regulated
banks. Credit substitution could occur through foreign banks operating
domestic branches that are not subject to capital regulation by the domestic
supervisor, or through bond and stock markets. The UK experience for the
period 1998-2007 is ideally suited to address these questions, given its
unique regulatory history (UK bank regulators imposed bank-specific and
time-varying capital requirements on regulated banks), the substantial
presence of both domestically regulated and foreign regulated banks, and the
United Kingdom’s deep capital markets. We show that leakage by foreign
branches can occur either as a result of competition between branches and
regulated banks that are parts of separate banking groups, or because a
foreign banking group shifts loans from its UK-regulated subsidiary to its
affiliated branch. The responsiveness of affiliated branches is nearly twice
as strong. We do not find any evidence for leakages through capital markets.
These findings reinforce the need for the type of international co-ordination,
specifically reciprocity in capital requirement regulation, which is embedded
in Basel III and the European CRD IV directive, which will be gradually phased
in starting January 2014. |