Olszak, Małgorzata Anna and Pipien, Mateusz and Roszkowska, Sylwia and Kowalska, Iwona, The Effects of Capital on Bank Lending in EU Large Banks – The Role of Procyclicality, Income Smoothing, Regulations and Supervision (December 29, 2014). University of Warsaw Faculty of Management Working Paper No. 5. Available for download at SSRN: http://ssrn.com/abstract=2543675

“This paper aims to find out what is the impact of bank capital ratios on loan supply in the EU and what factors explain potential diversity of this impact. Applying Blundell and Bond (1998) two step GMM estimator, we show that, in the EU context, the role of capital ratio for loan growth is stronger than previous literature has found for other countries. Our study sheds some light on whether procyclicality of loan loss provisions and income smoothing with loan loss provisions contribute to procyclical impact of capital ratio on loan growth. We document that loan growth of banks that have more procyclical loan loss provisions and that engage less in income smoothing is more sensitive to capital ratios. This sensitivity is slightly increased in this sample of banks during contractions. Moreover, more restrictive regulations and more stringent official supervision reduce the magnitude of effect of capital ratio on bank lending. Taken together, our results suggest that capital ratios are important determinant of lending in EU large banks.”