Capital Optimization: A Multi-Country Study of the Effect of the Basel Accord on Bank Lending

Abstract

This paper analyzes the impact of minimum capital requirements mandated by the first Pillar of the Basel Accord on bank lending across 166 countries from 2001 to 2015. Using panel data from 17,971 banks provided by Bankscope, this study adds to the existing literature by conducting a multi-country research on the effects of the newest phase of the regulation – Basel III – as well as estimating individual impacts on different types of banks and countries of varying income levels. By modelling bank behavior as a simultaneous decision-making process, the methodology employed in this investigation estimates the capital levels and loan rates through a 2SLS fixed-effects regression and finally the loan volume through a heteroskedasticity-adjusted OLS regression using predicted interest rates. Results suggest that on an aggregate basis, the implementation of the Accord, or a 4.5 percentage point increase in the Tier 1 capital ratio, raised loan rates and exerted downward pressure on bank credit, decreasing the quantity of loans by 0.04 percentage points. Evidence also found support for the argument that higher income countries tend to experience greater declines in loan volumes than lower income countries. Among different types of institutions, commercial banks and savings banks saw the largest reduction in lending.