Capital Requirements in Supervisory Stress Tests and Their Adverse Impact on Small Business Lending

Abstract

This paper estimates the implicit capital requirements in the U.S. supervisory stress tests. Our results show that stress tests are imposing dramatically higher capital requirements on certain asset classes – most notably, small business loans and residential mortgages – than bank internal models and Basel standardized models. By imposing higher capital requirements on loans to small businesses and mortgage loans, stress tests are likely curtailing credit availability for the types of borrowers that lack alternative sources of finance. In addition, we identify the impact of supervisory stress tests on the availability of credit to small businesses by analyzing differences in small business loan growth at banks subject to stress tests versus those that are not. Our results indicate that the U.S. stress tests are constraining the availability of small business loans secured by nonfarm nonresidential properties, which accounts for approximately half of small business loans on banks’ books.

Keywords: Capital requirements, supervisory stress tests, bank lending, small business lending

JEL Classification: G18, G21, G28