Differentiated deleveraging: How do banks respond to capital ratios and capital requirements?

We study the heterogeneous relationship between bank capital ratios, capital requirements, bank lending and loan pricing using data on portfolios and bank characteristics for a sample of large European banks in the period 2014-2025. Exploiting dynamic panel data models with parameter heterogeneity, we relate time-varying bank capital ratios and bank capital requirements to portfolio exposures and loan rates. We establish a pattern of differentiated deleveraging whereby higher capital ratios are associated with smaller portfolio sizes, but only for high-risk portfolios and banks with low leverage ratios. On the pricing side, higher capital requirements are associated with only a small increase in portfolio loan rates. The empirical evidence suggests that, once banks are adequately capitalized, capital requirements can be varied without causing substantial changes in bank loan supply and loan pricing.

Keywords: Bank lending; capital ratio; capital requirement; loan pricing; panel data model
JEL codes C23; C54; G21; G28

Working paper no. 862