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Capital and Liquidity Requirements: Impact on Bank Lending Spreads

Capital and Liquidity Requirements:
Impact on Bank Lending Spreads


Vighneswara Swamy Ph.D*


Abstract

This study provides an estimation of bank lending spreads in the context of new capital and liquidity requirements proposed under Basel III by constructing a stylized representative bank’s financial statements. We Show that the higher cost associated with a one-percentage increase in the capital ratio can be recovered by increasing lending spreads. The results indicate that in the case of scheduled commercial banks, one-percentage point increase in capital ratio can be recovered by increasing the bank lending spread by 31 basis points and would go upto an extent of 100 basis points for six-percentage point increase assuming that the risk weighted assets are unchanged. We also provide the estimations for the scenarios of changes in risk weighted assets, changes in return on equity (ROE) and the cost of debt.

JEL Classification: G2; G21; G28; E44; E51; E61

Keywords: Banks, Regulation, Basel III, Capital, Liquidity, Lending Spreads


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