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Friday, March 20, 2015

Higher Capital Requirements Will Cause Loan Demand Decline

Increasing capital requirements on bank holding companies (BHCs) lead to increased loan rates, resulting in a decrease in loan demand, according to a recent study by the IMF. “[A]n increase in the capital ratio of 2.5 percentage points (which is the size of the capital conservation buffer, proposed under Basel III) will lead to 7 to 8 basis point increases in loan rates, roughly a 5% increase.” The increase in loan rates leads to a subsequent drop in loan demand of approximately 4%.

The study, performed on the largest 250 BHCs over the 2001Q1 to 2014Q1 period, shows that when BHCs hold a surplus of capital above their desired level, the cost of holding more capital translates to higher loan rates. The increase to the risk-based total capital ratio contemplated in Basel III will increase loan rates by up to 12 basis points in two quarters, as well as a 10% decline in loans in the first quarter.

Read the IMF study.

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