Resource title

Capital Requirements and Banks’ Leniency

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Resource description

We investigate the effect of changes in capital regulation on the strictness(leniency) of loan terms using a simple model of bank capital requirements andasset quality examinations. Banks offer different levels of "leniency" in the senseof willingness to offer automatic extensions of loans in the presence of temporarypayment difficulties of borrowers. Banks offering lenient (less strict) loan termsmust have higher initial levels of capital and charge higher loan rates. Whencapital requirements are increased, both strict and lenient banks hold higher levelsof initial capital and they raise loan rates. As capital requirements increase thedifference between initial capital levels and between interest rates of strict andlenient banks decrease. Thus, higher capital requirements in recessions tend toreduce the interest rate premium paid for leniency. If a recession is interpreted asan increase in the required return, the interest rate premium paid for leniency isincreased in recession at a given level of required capital.

Resource author

J. Kimball Dietrich, Clas Wihlborg

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Resource publish date

Resource language

eng

Resource content type

application/pdf

Resource resource URL

http://hdl.handle.net/10398/6804

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