International audienceThis paper analyses the impact of loan market competition on the interest rates applied by euro area banks to loans during the 1994-2004 period, using a novel measure of competition called the Boone indicator. We find evidence that stronger competition implies significantly lower spreads between bank and market interest rates for most loan market products, in line with expectations. This result implies that stronger competition causes both lower bank interest rates and a stronger pass-through of market rate changes into bank rates. Evidence of the latter is also presented by our error correction model for bank rates. Further, banks compensate income losses from increased loan market competition by offering lower deposit rates. Our findings with respect to the loan market rates have important monetary policy implications, as they suggest that measures to promote competition in the European banking sector are likely to render the monetary policy transmission mechanism more effective

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The aim of the present paper is to assess the pro-cyclical impact of risk-sensitive bank capital. We develop a theoretical model where banks may apply two capital management rules: (i) either keep a constant, time-invariant, capital to loan ratio for all loans ("flat" capital ratio), (ii) or hold distinct, time-variant, capital to loan ratios depending on the measured riskiness of the loans ("risk-based" capital ratio). Despite its inherent cyclicality we show that the risk-sensitive capital rule may work to stabilize banks' supply of credit over the business cycle when the credit market is characterised by over-investment, i.e. credit standards are loose and resources are inefficiently allocated to risky projects. In this case the decrease in the capital-to-high-quality-loan ratio in good times provides banks with more leeway to lend to high quality borrowers, limits the search for higher but riskier yields, reduces over-investment, and ultimately smoothes the credit cycle. We test the relevance of this stabilizing effect using quarterly balance sheet data from a panel of US banks over the period 2003-2007. This period, characterized by easy access to credit and-presumablyover-investment, is particularly well suited for our test. We start by partitioning our sample of banks into two groups: banks whose capital to asset ratio has been observationally counter-cyclical, and banks whose capital has been either flat or pro-cyclical over our sample. We then compare the elasticities of credit to GDP across the two groups. Although such partitioning works to biase our statistical test against finding stabilizing effects, we find that banks with counter-cyclical, risk-sensitive, capital ratios have been the least sensitive to the business cycle. This paper thus provides both theoretical support for and empirical evidence of the stabilizing effects of risk-sensitive bank capital management.

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