The Impact of Quantitative Easing and Capital Requirements on Bank Lending: an Econometric Analysis

Spaltro, Marco (2013) The Impact of Quantitative Easing and Capital Requirements on Bank Lending: an Econometric Analysis. PhD thesis, Birkbeck, University of London.

Abstract

One of the key problems of the current financial crisis is weak bank lending growth. Shortages of capital, low liquidity buffers and weak demand for bank lending have been identified as possible contributors to bank lending weakness. Given that credit booms and busts have important implications for both monetary and financial stability, policymakers acted swiftly to shore up bank lending growth by supporting demand for lending through unconventional monetary policy and by establishing a macroprudential policy framework to limit future imbalances within the financial system. While the rationales for the use of unconventional monetary policy and the establishment of a macroprudential policy framework are different, they both target, directly or indirectly, bank lending growth to achieve their objectives. The main contribution of this thesis is to estimate the impact of quantitative easing and macroprudential policy on bank lending growth by using a non-publicly available bank panel dataset of UK banks since the late 1980s. This dataset was constructed by the Bank of England by merging Bank of England balance sheet and income statement data (including sectoral lending) with FSA regulatory returns data on capital (including bank-specific capital requirements). Differently from other research, we are able to estimate our relationships using data spanning two business cycles and to study the impact of these policies on various types of sectoral lending. We find that these new policies are non-neutral from a bank lending perspective, even though to a different extent. In particular, we find that quantitative easing in the UK has a positive impact on bank lending even though not particularly large. There is evidence that these effects may have been more important for small rather than large banks. Moreover, we also find that the effect of QE may have been smaller during the financial crisis because of lower capital ratios in the banking system. We show that changes in capital requirements (a possible macroprudential tool) affect bank capital decisions as banks try to maintain a constant buffer above capital requirements. As banks change their capital structure, bank lending growth is affected. However, there is heterogeneity in the reaction to changes in capital requirements, as large banks do not change their lending behaviour following a regulatory shock. We also provide preliminary evidence that banks respond to a regulatory shock by reducing their exposure to riskier assets in order to decrease their risk weighted assets and boost their regulatory capital ratio by reducing lending to private non-financial corporations. These findings have important policy implications. First, quantitative easing in the UK is effective in increasing bank lending growth but our simulations suggest that the amount of gilts purchased by the Bank of England may not be enough to provide a significant stimulus to bank lending growth. Moreover, these purchases may have been less effective during the crisis period because of capital constraints in the banking sector. These results suggest that larger asset purchases are needed to significantly increase bank lending and that the effect of asset purchases can be magnified by further strengthening banks' capital positions. Second, capital requirements may be an effective macroprudential policy tool and could be used by new macroprudential regulators to reduce bank lending growth in boom times in order to contain systemic risk. However, these effects may be smaller than initially envisaged as large banks seem insensitive to policy changes. There may be various reasons why these banks do not react to changes in capital requirements. For example, large banks' better access to capital markets may allow these banks to operate with smaller capital buffers. Moreover, if large banks do not react to capital requirements because of their systemic importance (e.g. because the threat of default is not credible), changes in the structure of the financial system may be necessary to enhance the impact of macroprudential policy.

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