Procyclicality of Banks’ Capital Buffer and its Impact on Bank’s Lending Activity in ASEAN Countries

Abstract

By developing two models to estimate the effect of business cycle on bank’s capital buffer and the effect of capital buffer on bank’s loan supply on annual panel data (1997-2009) of 63 commercial banks in five ASEAN countries, we find strong evidence of procyclicality pattern of capital buffer among banks in ASEAN countries. Banks are found to reduce their loan growth when business cycle turns downwards due to the impaired lending capacity as a result of a need to raise capital buffer to cover increasing riskiness of the credit default. Nevertheless, this procyclicality effect is somewhat small, given that a decrease of 1 percentage point in GDP growth will reduce loan growth by around 0.4 percentage points due to the rise of capital buffer. As Basel Committee for Banking Supervision (2010) proposes a new capital requirement regime to address issue of procyclicality of capital requirement, this empirical finding may become input for ASEAN country’s bank regulator in determining optimal countercyclical capital buffer level in such a way that this macro prudential measure will provide banks greater resilience that support them for reasonable lending activities during the downturn sides of business cycle while effective to prevent volume of credit from being excessive during the upturn sides of business cycle.

Keywords: Capital buffer, Procyclicality, Business cycle

JEL Classification: E32, G21