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Quality of Bank Capital and Bank Lending Behaviour During the Global Financial Crisis

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Financial Institutions in the Global Financial Crisis

Abstract

Using a worldwide bank sample from 2000 to 2010, this chapter analyzes the determinants of bank lending behavior during the global financial crisis, highlighting the role of bank capital. It reveals that the high quality of the bank funding strategy (tier 1 bank capital and retail deposits) and prevalent government backing were crucial to continuous bank lending during the crisis period.

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Notes

  1. 1.

    Statement by Chairman Ben S. Bernanke, 7 June, 2012, http://www.federalreserve.gov/newsevents/press/bcreg/bernanke20120607a.htm.

  2. 2.

    www.eba.europa.eu/News--Communications/Year/2012/Update-implementation-capital-exercise.aspx.

  3. 3.

    Vikram Pandit, We must rethink Basel or growth will suffer, Financial Times, 10 November, 2010.

  4. 4.

    Although several studies point to the inefficiency of government ownership and benefits of foreign ownership on bank efficiency (see, e.g., Berger et al. 2009; Bonin et al. 2005a, b; Shen and Lin 2012; Shen et al. 2014), others stress the negative impact of foreign ownership on the quality of governance (e.g., Lensink et al. 2008) or analyze alternative institutional forms [e.g., Columba et al. (2009, 2010) argue that mutual guarantee institutions may alleviate access to finance for SMEs].

  5. 5.

    Berrospide and Edge (2010) analyze lending by the U.S. Bank Holding Companies to confirm a positive but small effect of bank capital on lending. Cornett et al. (2011) analyze the relationship between credit supply and liquidity and capital positions of all U.S. commercial banks during the global financial crisis. They focus on liquidity risk management and do not distinguish between different types of bank capital. Carlson et al. (2013) develop a novel empirical matching strategy to confirm the positive relationship between capital ratios and bank lending in the U.S. during the global financial crisis.

  6. 6.

    Demsetz et al. (1996) analyze the relationship between franchise value and risk-taking in banking. In line with Keeley (1990), they show that banks with high franchise values have much to lose in insolvency. Consequently, the high-franchise-value banks hold more capital and take on less risk than banks with lower franchise value in order to prevent insolvency from occurring. Banks’ risk-taking may be driven by the banks’ business models (Altunbas et al. 2011) or by the macroeconomic environment [e.g., an extended period of low interest rates; see Altunbas et al. (2012), or market power; see Berger et al. (2009b)] and may be mitigated by recapitalization measures or regulatory interventions (Berger et al. 2012). Rather than on risk-taking in general, our focus is on the determinants of bank lending behavior.

  7. 7.

    Hasan et al. (2015) discuss how to construct market-based capital requirements by using market data in conjunction with regulatory data to estimate a bank’s total risk. They show that capital adequacy metrics thus constructed outperform VaR-based capital models as well as purely market-based capital models that rely on CDS premia.

  8. 8.

    Ivashina and Scharfstein (2010) provide some evidence that banks with better access to deposits restrict their lending to a lesser extent and are less affected by the banking crisis than banks with limited access to deposits.

  9. 9.

    Table B.2 in Appendix B gives a summary about the number of observations in our sample countries from 2001–2010.

  10. 10.

    The Hausman test indicates that a fixed effects model should be used rather than a random effects model.

  11. 11.

    The bank capital structure decision is endogenous and may depend on bank-specific variables and macroeconomic and regulatory conditions in a country (see Byoun 2008; Gropp and Heider 2010; Flannery and Rangan 2008; Memmel and Raupach 2010).

  12. 12.

    Ashcraft (2008b) and Berger and Bouwman (2013) also employ tax rate as an instrumental variable. Alternatively, Billmeier and Nannicini (2013) employ a synthetic control approach to control for endogeneity issues in a cross-country study.

  13. 13.

    We also tested for alternative empirical specifications, which include a yearly change in interest rate and its interactive term with the crisis dummy as additional explanatory variables. Their impact on bank lending behavior was statistically insignificant in normal times and during the global financial crisis. Our other results remain largely unchanged. This confirms the importance of tier 1 capital put forward within the lending channel literature (see Gambacorta and Marques-Ibanez 2011).

  14. 14.

    Brewer et al. (2008), for example, show that capital ratios of banks not only depend on bank-specific variables, but also on country characteristics and policy variables. In addition, Berger et al. (2008) demonstrate that U.S. bank holding companies actively manage their capital ratios. One can therefore expect the relationship between capital and credit growth to be country-specific as well.

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Acknowlegements

This chapter is co-authored with Marko Košak, Igor Lončarski and Matej Marinč. We wish to thank Jonathan Batten, Arnoud Boot, Nadia Massoud, and Razvan Vlahu, as well as the participants at the EBES 2012 Conference, the Australasian Finance and Banking Conference 2012, and INFINITI 2013 for valuable comments. This chapter was published in International Review of Financial Analysis.

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  1. School of Economics and Management, Southeast University, Nanjing, Jiangsu, China

    Shaofang Li

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Li, S. (2018). Quality of Bank Capital and Bank Lending Behaviour During the Global Financial Crisis. In: Financial Institutions in the Global Financial Crisis. Springer, Singapore. https://doi.org/10.1007/978-981-10-7440-0_3

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