Bank capital requirements and risk-taking: Evidence from basel III

Abstract

We study the effects of both tighter and looser bank capital requirements on bank risk-taking. We exploit credit register data matched with firm and bank level data in conjunction with changes in capital requirements stemming from Basel III, including the introduction of a SME supporting bank capital factor in the European Union. We find that tighter capital requirements reduce the supply of bank credit to firms, while looser capital requirements mitigate the credit supply effects of increasing capital. Importantly, at the loan level (credit supply), banks more affected by capital requirements change less the supply of credit to riskier than to safer firms, and these asymmetric effects occur for both the tightening and the loosening of bank capital requirements. Finally, these effects are also important at the firm-level for total credit availability and for firm survival. Interestingly, our results suggest that those banks most impacted by the tighter Basel III capital requirements prioritize credit among ex-ante riskier firms to avoid their closure, consistent with loan evergreening.