Regulatory capital requirements for banks have been a topic of heated discussions by academicians, bankers, and policy makers for decades. Central to these discussions is how costly requiring banks to fund themselves with more equity (rather than cheaper deposits) is and how these possible regulatory costs are transmitted to bank borrowers. In a recently published RCFS paper, “How Do Capital Requirements Affect Loan Rates? Evidence from High Volatility Commercial Real Estate,” David Glancy and Robert Kurtzman study these important questions. They specifically ask how capital requirements affect loan rates in the commercial real estate market. Their focus is high volatility commercial real estate loans, as the risk weights used in calculating regulatory capital for these types of loans recently increased. The authors exploit within-bank variation in capital requirements, allowing them to identify the effect on loan rates while controlling for bank-level confounders. Importantly, they find that a one-percentage-point increase in capital requirements raises loan rates by 8.5 basis points, with this estimate being the steady-state cost—rather than transition costs—of capital requirements as shown by the authors with further tests. The loan rate elasticity identified in this paper will be a key parameter in future research on the optimal level of capital requirements.
Spotlight by Isil Erel
Photos courtesy of David Glancy and Robert Kurtzman