The Role of Capital and Liquidity in Bank Lending: Are Banks Safer?

Abstract

The aim of this paper is to examine whether and to what extent bank capital requirements and liquidity standards influence the level of bank stability. Our approach is that both capital and liquidity affect lending growth, which in turn affects bank stability. We construct a panel dataset on a sample of 2,054 commercial banks from 117 developed and developing countries during the 2000-16 period. By applying a two-stage least squares (2SLS) empirical methodology, our findings show that capital and liquidity have a negative direct impact on the level of bank stability. However, this influence is counteracted by an indirect positive effect through the increased level of credit. Our results are not homogeneous across legal and institutional environments. In particular, we provide evidence on more relevant relationships in countries with higher level of protection of creditor rights and lower restrictions on non-traditional banking activities. Our empirical findings are robust to different specifications of the empirical model and to potential endogeneity problems. Policy Implications• Notwithstanding the tightening Basel III regulation, lending has increased in the presence of higher capital requirements and liquidity coverage ratios. However, this increased in lending is not independent upon the legal and institutional setup.• Although it is fundamental to study the direct effects of capital and liquidity requirements on stability, policymakers should deal not only with these direct effects, but also with the different channels of this transmission mechanism and, specifically, with the lending channel.

Internal Factors Affecting Commercial Bank Lending: Symmetric and Asymmetric Effects of Macro-Level Data Evidence

“…Meanwhile, CAR positively affects bank loans. These results are consistent with the findings of research conducted by Prawitasari et al (2020) and Polizzi et al (2020) that CAR has a significant positive effect on bank credit provision. These results are also in line with the findings of a study conducted by Miyajima (2020), which found strong evidence that the capital ratio positively affects bank lending.…”

“…However, the findings of this study are consistent with the results of a study conducted by Zulkifli et al (2018) based on firm-level data. This finding is also in line with the results of Cucinelli (2015), Miyajima (2020), andPolizzi et al (2020) that NPL negatively affects bank loans. So, the NPL negatively affects bank loans.…”

“…These results are in line with the findings of Rabab'ah (2015), Moussa and Chedia (2016), Adzis et al (2018), Bhattarai (2020), and Nguyen and Dang (2020). On the other hand, these results are not in line with Isa et al (2019) and Polizzi et al (2020), which found a positive effect of liquidity on the bank loan. However, the bank's higher liquidity asset ratio will reduce bank lending as measured by the LDR without moral hazard from the bank's decision.…”

“…Also, according to Prawitasari et al (2020), that CAR positively and significantly affects bank lending. Similarly, Polizzi et al (2020) prove that the capital ratio positively and significantly affects the growth of bank loans. The explanation of the results of previous studies that prove the logic of the theory supports the formulation of the following second hypothesis: H2: Capital adequacy ratio positively affects bank lending, both symmetrically and asymmetrically…”

“…Through a study of bank-level data, Miyajima (2020) found evidence that NPLs negatively affect bank lending. Also, the research conducted by Polizzi et al (2020) proves that NPLs negatively and significantly affect the growth of bank credit. The theoretical logic supported by the results of previous research helps formulate the first hypothesis, which can be stated as follows: H1: Non-performing loan negatively affects bank lending, both symmetrically and asymmetrically…”