Authors: Dimitris Gavalas, Theodore Syriopoulos

Title: Filtering Loan and Interest Rates; the impact of Basel Regulations

Abstract

In late 2010, the Basel Committee on Banking Supervision issued the Basel III document enumerating measures focused on improvements in the definition of regulatory capital, introduction of a leverage ratio as a backstop for risk-based capital requirement, capital buffers, enhancement of risk coverage through improvements in the methodology to measure counterparty credit risk and liquidity measurement standards. This study investigates the impact of the new capital requirements on bank lending rates and loan growth introduced under the Basel III framework. Higher capital requirements lead to higher lending rates through the raise of banks’ marginal cost of funding. The results also suggest that banks’ responses to the new regulations will vary considerably from one European economy to another depending on cross-country variations in banks’ net cost of raising equity and the elasticity of loan demand with respect to changes in loan rates.