Balance Sheet Strength and Bank Lending During the Global Financial Crisis

Abstract

Non-technical summaryIn the wake of the global financial crisis there have been renewed efforts to rethink the regulatory framework of the banking system. Such efforts rest on the assumption that banks with stronger capital and liquidity buffers are more resilient to financial shocks. Stronger banks should also be less likely to curtail credit during times of stress. In this paper, we use highly disaggregated data on international bank lending to examine the link between balance sheet strength and the supply of bank credit. We focus on the syndicated loan market, a large international corporate credit market in which loans are extended by groups of banks rather than individual banks. Our sample comprises more than 800 banks from 55 countries that lent to borrowers in 48 countries during 2006-10.Our main contribution is to take a novel look at what constitutes a strong bank balance sheet. In doing so, we draw heavily on recent proposals for bank regulation under the Basel III framework. In particular, we compute a complex measure of structural liquidity (the 'net stable funding ratio') that helps gauge the stability of a bank's funding sources relative to the market liquidity profile of its assets. But we also use traditional variables of bank health that capture bank's dependence on non-deposit (or market) funding. These indicators of balance sheet strength, measured before the crisis, reflect banks' vulnerability to the financial market shocks that took place during 2007-08.We find that banks that were more dependent on market funding reduced their supply of syndicated loans more than other banks. However, bank capital played a cushioning role: bettercapitalized banks that were exposed to the financial market shocks decreased their supply of loans less than other banks. The only measure of capital that delivers this result is similar to the simple leverage ratio proposed under the Basel III framework. By contrast, the traditional Tier 1 and total regulatory capital ratios from the Basel II framework are less useful for distinguishing which banks were better able to sustain lending. These results underscore the importance of bank capital for the recovery of credit after crises.We conclude that banks with stronger balance sheets were better able to perform their intermediation function during the recent crisis. We examine the role of bank balance sheet strength in the transmission of financial sector shocks to the real economy. Using data from the syndicated loan market, we exploit variation in banks' reliance on wholesale funding and their structural liquidity positions in 2007Q2 to estimate the impact of exposure to market freezes during 2007-08 on the supply of bank credit.We find that banks with strong balance sheets were better able to maintain lending during the crisis. In particular, banks that were ex ante more dependent on market funding and had lower structural liquidity reduced the supply of credit more than other banks. However, higher levels of better-quality capital mitigated this effect. Our result...

Transmission of a global financial crisis shock to an emerging economy

“…The magnitude and statistical significance of the coefficients of the other control variables are mostly in line with the literature. We find positive coefficients for capital ratio, meaning that the better capitalized banks increased their lending after the crisis, confirming the findings of Kapan and Minoiu () that better capitalized banks can better withstand shock. However, we find negative coefficients for the liquid assets to total asset ratio, showing that the more liquid banks reduce their lending after the financial shock.…”

“…We focus on bank and borrower/loan characteristics and follow the literature (see, e.g., Khwaja & Mian, 2008;Schnabl, 2012;Baele et al, 2014;Farooq & Zaheer, 2015) when selecting and measuring these controls. Kapan and Minoiu (2013) show that better capitalized and more liquid banks were better able to continue credit supply during the 2007-2008 crisis. Building on this finding, we use the bank capital ratio as a proxy for solvency and the liquid assets to total assets ratio as a proxy for bank liquidity.…”

Estimating the direct impact of bank liquidity shocks on the real economy: Evidence from letter‐of‐credit import transactions in Colombia

“…Specifically, we classify those banks that experienced an increase in the wholesale funding ratio over the 2-year period from 2005 to 2007 as ex ante exposed to adverse liquidity shocks during the crisis, and others with a decrease in the wholesale funding ratio as unexposed. This measure, namely, the degree of wholesale funding exposure built up prior to the crisis, is in line with the literature that has shown that the reliance on wholesale funding was a major source of bank vulnerability during crisis periods (e.g., Huang & Ratnovski, 2011;International Monetary Fund, 2013;Ivashina & Scharfstein, 2010;Kapan & Minoiu, 2018). Another strand of literature has proxied bank-level liquidity shock with the degree of ex ante exposure to foreign lending shocks, based on bank's borrowing from foreign banks in previous periods (Ongena, Peydró, & Van Horen, 2015;Paravisini et al, 2015).…”

Are Islamic Banks More Resilient During Financial Panics?

“…Using data from 18 countries with substantial presence of Islamic banking, Č ihák and Hesse (2010) conclude that Islamic banks are financially stronger when they are small; however, they lose their relative strength as they grow bigger in size, which reflects challenges of credit risk management in large Islamic banks. This paper also contributes to the literature on the evidence of transmission of financial sector shock to the real sectors of the economy as documented by Kapan and Minoiu (2013), de Haas and van Horen (2013), Giannetti and Laeven (2012), Ivashina and Scharfstein (2010) and Khwaja and Mian (2008), among others. For example, Kapan and Minoiu (2013) use variation in banks' dependence on wholesale funding and their structural liquidity in 2007Q2 to gauge the impact of financial turmoil in bank funding markets during the global financial crisis on the supply of corporate loans.…”

“…This paper also contributes to the literature on the evidence of transmission of financial sector shock to the real sectors of the economy as documented by Kapan and Minoiu (2013), de Haas and van Horen (2013), Giannetti and Laeven (2012), Ivashina and Scharfstein (2010) and Khwaja and Mian (2008), among others. For example, Kapan and Minoiu (2013) use variation in banks' dependence on wholesale funding and their structural liquidity in 2007Q2 to gauge the impact of financial turmoil in bank funding markets during the global financial crisis on the supply of corporate loans. Their findings suggest that banks with stronger balance sheets, that is, banks with more high-quality capital and in a better structural liquidity position before the crisis, were better able to sustain the supply of credit to firms.…”