In Good Times and in Bad: Bank Capital Ratios and Lending Rates

Abstract

This paper investigates the relationship between bank capital ratios and lending rates using data from 1998 to 2012 for 13 large banks accounting for 75% of total UK lending. We document a substantial change in the coefficient of the Tier 1 capital ratio in reduced-form regressions for secured household lending rates; the coefficient changes from positive pre-crisis to negative in crisis. Significant changes are also detected in the relationship for unsecured household and corporate lending. Such instability is difficult to reconcile with many well-established theories of financial intermediation but is consistent with the relatively recent theories of bank portfolio decisions emphasising cyclical variation in bank leverage and risk-appetite.

Keywords: Bank capital; Interest margins; Bank regulation; Capital requirements

JEL Classification: G01, G18, G28, G32, G38