How Does Credit Supply Respond to Monetary Policy and Bank Minimum Capital Requirements?

43 Pages Posted: 11 Sep 2014

See all articles by Shekhar S. Aiyar

Shekhar S. Aiyar

International Monetary Fund (IMF)

Charles W. Calomiris

Columbia University - Columbia Business School; National Bureau of Economic Research (NBER)

Tomasz Wieladek

Bank of England

Date Written: September 5, 2014

Abstract

We use data on UK banks’ minimum capital requirements to study the interaction of monetary policy and capital requirement regulation. UK banks were subject to both time-varying capital requirements and changes in interest rate policy. Tightening of either capital requirements or monetary policy reduces the supply of lending. Lending by large banks reacts substantially to capital requirement changes, but not to monetary policy changes. Lending by small banks reacts to both. There is little evidence of interaction between these two policy instruments. The differences in the responses of small and large banks, and the lack of interaction between capital requirement changes and monetary policy, have important policy implications. Our results confirm the theoretical consensus view that monetary policy should focus on price stability objectives and that capital requirement changes are a more effective tool to achieve financial stability objectives related to loan supply. We also identify important distributional consequences within the financial system of these two policy instruments. Finally, our findings do not corroborate theoretical models that raise concerns about complex interactions between monetary policy and macroprudential variation in capital requirements.

Keywords: loan supply, capital requirements, monetary policy, macroprudential regulation

JEL Classification: G21, G18, E51, E52, E44

Suggested Citation

Aiyar, Shekhar S. and Calomiris, Charles W. and Wieladek, Tomasz, How Does Credit Supply Respond to Monetary Policy and Bank Minimum Capital Requirements? (September 5, 2014). Bank of England Working Paper No. 508, Available at SSRN: https://ssrn.com/abstract=2494187

Shekhar S. Aiyar

International Monetary Fund (IMF) ( email )

700 19th Street NW - HQ 5-403
Washington, DC 20431
United States
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Charles W. Calomiris

Columbia University - Columbia Business School ( email )

3022 Broadway
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New York, NY 10027
United States
212-854-8748 (Phone)
212-316-9219 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Tomasz Wieladek (Contact Author)

Bank of England ( email )

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London, EC2R 8AH
United Kingdom

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