Analysis Of Factors Influencing European Bank Credit

The euro area faces three interlocking crises that together challenge the viability ofthe currency union. There is a banking crisis–where banks are undercapitalized andhave faced liquidity problems. There is a sovereign debt crisis–where a number ofcountries have faced rising bond yields and challenges funding themselves. Lastly, thereis a growth crisis–with both a low overall level of growth in the euro area and anunequal distribution across countries.The strains experienced during the crisis crystallised in the banking system. Oneimportant lesson that policymakers have now recognized is that banks should hold morecapital to prevent losses from spilling over from the financial sector to the real economy.In many cases, the recapitalisations in the crisis, along with more generalised supportmeasures, averted the outright collapse of major banks under extremely adverse marketconditions. More generally, holding sufficient loss-absorbing capital is also thought tohave helped banks maintain their intermediation capacity and avoid a contraction ofcredit supply to firms and households.Against this background of bank credit,this paper will mainly analyzes the capitalof euro zone banks during the crisis how to affect the supply of bank credit, and theeffect of other factors (such as size, liquidity and market funding and so on). In the banklending channel literature,the effect of capitalisation on loan supply has been studiedmostly in normal times ans in terms of the reaction to monetary policy shocks.In thispaper,we extend the analysis to include the recent crisis experience. In the thirdchapter,we mainly discuss the effect of bank-specific characteristics on bank creditexpansion. Bank-specific characteristics discussed in this paper include size,liquidity,market funding and capital regulation. We consider that bank size have a negativeimpact on credit supply, as small banks tend to supply more lending to their clients.This can be explained by the strong lending relationship existent between small banksand small firms in many countries.In terms of liquidity, we assume that the banks arerational profit-seeking, so banks will try to lend in order to acquire the biggest profits asmuch as possible. Banks’ strong liquidity in the last year means that banks have moreloanable funds, so in the next year banks will be willing to increase the supply of credit.The structure of bank funding has also an impact on banks’ intermediation function.Banks with a lower reliance on market funding (higher share of deposits) tend to supply, other things being equal, more lending. In terms of regulatory capital, we know thatbank recapitalisation during the crisis is aimed to improve the level of bank capital toabsorb losses.In the empirical part, banks were selected in descending order of size, until coveragereached at leasted70%of the euro area banking assets reported in The Bank magazinefor the Top1000banks in2012. Our sample adopts an annual frequency and include43banks which are selected in the way stated above. It covers the13years from1999toend-2011, a period spanning different economics cycles.Our econometric model willintroduce a crisis dummy(before2008, crisis dummy takes on a value of0; from2008to2011, crisis dummy takes on a value of1) to distinguish the effect of bank-specificcharacteristics (especially the regulatory capital) on credit supply in normal times andcrisis period.The empirical results show that: although the effect of size, liquidity and wholesalefunding on bank loan growth in normal times is consistent with effect during a crisis,the effect of capitalisation is different.While stronger capitalisation sustains loan growthin normal times, banks during a crisis can turn additional capital into greater lendingonly once their capitalisation exceeds a critical threshold. Undercapitalised banks seekto restore their regulatory capital ratio without generating new lending. This suggeststhat recapitalisations help sustain credit in two ways, by helping banks to surviveextreme distress, and by moving capital ratios into a territory that allows banks toexpand their lending again.In addition, it is important to recognize that a singular focus on recapitalisationsand other measures to sustain bank credit may prove insufficient for generating asustainable recovery from a crisis. The authorities also need to take some measures toensure credit flow to productive sectors, in order to promote economic growth.