European Central Bank working paper finds capital buffer hikes cut lending more at capital-constrained banks during monetary tightening

The European Central Bank published a working paper analysing how euro area banks’ lending and risk-taking respond when monetary policy tightening coincides with macroprudential tightening via higher bank capital buffer requirements. It finds no statistically significant additional lending contraction for the average bank once the rate-hiking cycle started, but a clear amplification effect for banks with the least capital headroom. Using AnaCredit credit registry data combined with supervisory information on around 2,000 banks, the paper studies a wave of announced combined buffer requirement increases before the sharp and unexpected monetary tightening that began in 2022 Q3. For banks in the lowest tercile of capital headroom, a 1 percentage point increase in buffer requirements is associated with a further 1.3 to 1.8 percentage point decline in lending for existing relationships and a 2.5 to 4.4 percentage point lower likelihood of forming new bank-firm relationships, with evidence that firms could not readily offset reduced credit by switching to less constrained banks. The analysis also links tighter buffers in a rising-rate environment to lower risk-taking, including around a 4.5 percentage point reduction in loan-to-value ratios for newly originated loans and a 1.3 to 2.1 percentage point lower likelihood of using commercial real estate as collateral. The paper notes that these findings are the authors’ views and do not represent the European Central Bank’s views.