Annex I. Bank Capital and Credit Growth Study Summary
1. Determining the size and sign of the impact of bank capital to credit growth using various statistical regression or panel estimations does not yield a uniform message. Some studies suggest a strong positive impact, others a negative impact and other studies no relationship at all.
2. The positive relationship between bank capital and credit growth was most strongly evident during the recent financial crisis, banks with strong balance sheets were better able to maintain their lending. The study by Albertazzi and Marchetti (2010) uses Italian data in 2007–09 and finds evidence of a contraction of credit supply associated with low bank capitalization. Kapan and Minoiu (2013) employ a sample of more than 800 banks from 55 countries during 2006–10. They show that bank capital played a cushioning role: better capitalized banks (with lower leverage ratio) that were exposed to the financial market shocks decreased their supply of loans less than other banks. In conclusion, all studies referred to above suggest that higher capital makes the provision of credit more stable and robust even in economic downturns. More capital also allows banks to better withstand financial and real shocks. Bank capital increases the capacity to raise non-insured debt and thus banks’ ability to limit the effect of a drop in deposits on lending (Ashcraft, 2001). Indeed, using data for Italian banks in 1992–2001, Gambacorta and Mistrulli (2004) show that well-capitalized banks can better absorb temporary financial difficulties on the part of their borrowers and preserve long-term lending relationships.
3. However, studies that focus on banks in advanced economies during the 2008 crisis alone often come to different conclusions. Using OECD data Huang and Ratnovski (2009) find no relationship between pre-crisis bank capital and performance during the crisis. For their sample of European banks, Camara et al. (2010) report that well-capitalized banks took more risk before the 2008 crisis. Using a sample of 36 major global banks, the IMF’s GFSR (2009) finds that banks that received government support during the crisis had statistically higher capital metrics before the crisis. To sum up, empirical evidence fails to provide a definitive answer on whether higher capital will always and everywhere enhance financial stability. However in this paper we side with the view that higher capital will increase banks’ resilience, support credit to productive sectors of the economy and will reduce losses in a crisis period.
Albertazzi, Ugo and Domenico J. Marchetti, 2010, “Credit Supply, Flight to Quality and Evergreening: An Analysis of Bank-Firm Relationships After Lehman”, Banca d’Italia Working Paper No. 756.
Bernanke, B. S., Lown, C. S., and Friedman, B. M., 1991, The Credit Crunch, Brookings Papers on Economic Activity 1991 (February), pp. 205–47.
Berrospide, J. M. and Edge, R. M., 2010, The Effects of Bank Capital on Lending: What do we Know, and what does it mean?, International Journal of Central Banking.
Caceres, C., and F. Rodrigues Bastos, 2016, “Understanding Corporate Vulnerabilities in Latin America,” IMF Working Paper No. 16/80 (Washington: International Monetary Fund).
Calomiris, C. W. and J. R. Mason, 2003, Consequences of Bank Distress during the Great Depression. American Economic Review 93 (March), pp. 937–47.
Camara, Boubacar, Laetitia Lepetit and Amine Tarazi, 2010, “Changes in Capital and Risk: AnEmpirical Study of European Banks,” Working Paper, Universite de Limoges, Limoges Cedex, France.
Carlson, M., Shan, H., and M. Warusawitharana, 2013, Capital Ratios and Bank Lending: A Matched Bank Approach, Journal of Financial Intermediation, Vol. 22 (April), pp. 663–87.
Duan, J., W. Miao, and J. A. Chan-Lau, 2015, “BuDA: A Bottom-Up Default Analysis Tool,” Unpublished, Risk Management Institute, National University of Singapore and International Monetary Fund.
Francis, W. B. and Osborne, M., 2012, Capital Requirements and Bank Behavior in the U.K.: Are There Lessons for International Capital Standards?, Journal of Banking and Finance, Vol. 36 (March), pp. 803–16.
Gambacorta, L. and Mistrulli, P. E., 2004, Does Bank Capital Affect Lending Behavior?, Journal of Financial Intermediation, Vol. 13 (April), pp. 436–57.
International Monetary Fund, Global Financial Stability Report, 2009, “Responding to the Financial Crisis and Measuring Systemic Risks,” Chapter 3, Detecting Systemic Risk, April.
International Monetary Fund, Global Financial Stability Report, 2015, “Vulnerabilities, Legacies, and Policy Challenges: Risks Rotating to Emerging Markets,” Chapter 3, Corporate Leverage in Emerging Markets—A Concern?, October.
International Monetary Fund, Global Financial Stability Report, 2016, “Potent Policies for a Successful Normalization,” Chapter 2, The Growing Importance of Financial Spillovers from Emerging Market Economies, April.
International Monetary Fund, 2016, “Understanding Corporate Vulnerabilities in Latin America.” Chapter 3 in Regional Economic Outlook: Western Hemisphere, April.
Kapan, Tümer and Camelia Minoiu, 2013, “Balance Sheet Strength and Bank Lending During the Global Financial Crisis,” IMF Working Paper No. 13/102 (Washington: International Monetary Fund).
Izabela Karpowicz and Mohamed Afzal Norat, 2015b, 2012 FSAP Recommendations Status and Implementation Report, 2015 Article IV Selected Issues Paper, pp. 67–88, June.
Lemus-Esquivel J. S, Quicazán-Morenoy C. A, Hurtado-Guarínz J. L, Lizarazo-Cuéllarx, A., 2015, Financial Soundness Index for the Private Corporate Sector in Colombia, Banco de La Republica, Temas de Estabilidad Financiera, No. 82, July.
Li, Delong, Nicholás Magud and Fabián Valencia, 2015b, “Financial shocks and Corporate Investment in Emerging Markets: Financing vs Real Options Channel,” IMF Working Paper No. 15/285, (Washington: International Monetary Fund).
Moody’s Investor Service, 2015a, “Resilience to Slower Economic Growth Supports Stable Outlook,” Banking system Outlook—Colombia, 3 November.
Moody’s Investor Service, 2015b, “Stress Tests Reveal Capital Weaknesses in Some Banking Systems”, Banks—Latin America, Sector In-Depth, 15 December.
Martynova, Natalya, 2015, Effect of Bank Capital Requirements on Economic Growth: a Survey, DeNederlandscheBank, DNB Working Paper No. 467, March.
Repullo, R. and Suarez, J., 2013, The Procyclical Effects of Bank Capital Regulation, Review of Financial Studies, Vol. 26 (February), pp. 452–90.
Prepared by Mohamed Afzal Norat and David Jutrsa (MCM). We would like to thank Jorge Roldos, Daniel Rodríguez-Delgado, Maria Angelica Arbelaez, Esteban Gomez and Juliana Lagos for useful comments.
The terms –/+ refer to negative and positive impact on key macroeconomic variables (profits, output, investment, trade balance and growth) due to impact on corporates. For example, higher corporate distress would have a negative impact on Colombian corporate profitability, output, investment and growth. The impact on exports and import substitution could be positive. Overall the impact could be uncertain.
For further details, see Financial Stability Report, Banco de La Republica, September 2015.
The following section utilizes data from private vendors and corporate databases the latest 2015 data for the whole sample of firms is not available at this time. As Colombian corporate nonfinancial corporate switch to reporting on an IFRS basis, the timeliness and quality of corporate data is expected to improve.
ICR is computed as EBIT divided by interest expense; EBIT is earnings before interest, and taxes.
Evidence for DAR for a much broader smaller-sized set of fragile firms undertaken by Banco de la Republica in its latest Financial Stability Report indicate much higher levels of DAR (around 30 percent). Our much smaller sample of the larger firms are not comparable as earnings and debt dynamics differ considerably across different sized firms. For the sample of firms analyzed by BanRep, the fraction of fragile firms has been relatively flat around 30–35 percent even under shocks.
Our thanks are due to Esteban Gomez and his team at the Financial Stability department of the Banco de La Republica for the data, construction and calculation of the FSI metrics, validation tests and distributions for defaulting and non-defaulting firms. The data on firms used to construct these metrics account for around 48 percent of the commercial loan portfolio—they are a key set of debtors in the Colombian financial system. The work in this section is based on Lemus-Esquivel et al (2015). Again, in line with 2015 corporate data unavailability until June 2016, the composite metric was not available for 2015.
Defaulting firms are those defined as those moving from higher ratings (A or B) to lower ratings which could be defined as distress ratings (C, D, or E) during a given year. More details are provided in Lemus-Esquivel et. al. (2015).
Data was provided by the Financial Superintendency of Colombia for the following banks: Bancolombia, Banco de Bogota, Banco Davivienda, BBVA Colombia, Banco de Occidente, Banco Corpbanca, Banco GNB Sudameris, Banco Colpatria, Banco Popular, and Citibank Colombia. We would like to express our gratitude to Juliana Lagos and her staff for their excellent interaction and communication with the IMF team regarding this information.
It is not always the case that corporates are able to hedge their FX exposure due to very specific nature of risks their exposure involves (in terms of maturity, size, currency and cost). Even if such exposures can be hedged the hedge could be less than effective due to knock-out thresholds depending on the amount of depreciation (i.e. effective if depreciation is below 30 percent only) and mismatches in maturity of FX derivative instruments (of shorter term) used to hedge compared to longer maturity of the corporate exposure. Moreover, this could also entail additional rollover and liquidity risks as the FX derivatives contract expire while market and credit risks (from margin, collateral re-setting) would exist prior to maturity of the contracts. Surveys of the effectiveness of hedges from derivatives would have to be undertaken for nonfinancial and financial corporate by the Corporate and Financial Superintendencies. Further work by supervisors would help to address the strength of mitigating actions that nonfinancial and financial corporations can take against financial shocks (especially FX shocks).
However if earnings were to decline to 40 percent (2 banks become close to regulatory minimum of 9 percent) while total median capital would be lower at around 12.1 percent. If earnings were to collapse to around 60 percent declines 2 banks would be below the regulatory minimum and one other bank close to the 9 percent threshold while total median capital for the banks would be around 11.2 percent.
While the focus on this paper is on static stress tests the BdR has undertaken dynamic stress tests in the Financial Stability Report, September 2015 in which the deterioration of the corporate portfolio is taken into account.
SFC regulations since 23 August 2012 have made clear that all intangibles whenever it was registered are to be deducted by credit institutions from capital and do not act as fully-loss absorbing capital.
Tangible common equity is a standardized definition of capital used by Moody’s in its stress tests to ensure comparability across its rating universe of 900 banks in 80 banking systems. It differs from regulatory capital measures of capital such as common equity tier 1 (CET1).
This includes all earnings and FX shocks as well as offsetting impact on loss-absorbency and capital from running down provisions and net income.
The regulatory decree strengthened the criteria for debt instruments to be recognized as capital Tier 1 and Tier 2.