Is Tighter Bank Regulation Restricting Loan Growth?

This blog post presents evidence that the supply of residential mortgage loans, credit card loans and small business loans has been significantly restricted by the swarm of new financial regulations that have been introduced in recent years. For instance, there is a large academic literature on the relationship between capital requirements and loan growth which consistently shows that higher capital requirements reduce the supply of credit and increase lending rates. In a recent survey of the academic literature, Martynova (2015) reports that a one percentage point increase in capital requirements is associated with a decline in lending between 1 and 5 percentage points, and an increase in lending rates between 3 to 15 basis points.1 Moreover, bank-dependent borrowers – such as households and small businesses – are likely to be the types of borrowers most impacted by the increase in banks’ capital requirements since the alternative sources of lending provided by nonbanks and online lenders are quite expensive.2

In this blog post we identify the effect of tighter capital and other regulatory requirements on bank lending by analyzing differences in loan growth at banks above $50 billion – those that are subject to more stringent regulation such as stress tests, higher capital requirements, new liquidity requirements, a shift from short to long-term liabilities under the total loss absorbing capacity standard, and more stringent credit limits for inter-SIFI exposures – versus banks with assets below $50 billion. Because smaller banks are subject to less stringent capital requirements and are exempted from liquidity and other regulatory requirements, they can act as a “control” group in assessing the impact of new regulations on the supply of credit.

Our data on lending are from the Consolidated Reports of Conditions and Income for commercial banks published by the Federal Deposit Insurance Corporation (Call Reports) covering the period from 2007:Q1 to 2016:Q2. To be included in the large bank group, the sum of total assets across all subsidiaries of a given bank holding company must be ranked in the top thirty-three bank holding companies each quarter, a cutoff that is consistent with the stress-testing requirements mandated by the 2010 Dodd-Frank Act.3 Although American Express Company is not ranked in the top 33 bank holding companies, it is included in the large bank panel in order to achieve a more accurate depiction of credit card loan growth at large banks. Since the first time the capital adequacy of the banking system was formally assessed under the Comprehensive Capital Analysis and Review (CCAR) was in February 2011, loans on banks’ books are normalized to 100 in the first quarter of 2011.

Figure 1 shows aggregate loan growth at large versus small banks. Between the first quarter of 2011 and mid-2016, loans on large banks’ books increased about 25 percent while they rose close to 45 percent at small banks.  This translates into an average loan growth rate of 4 percent per annum at large banks and 7 percent at small banks. In the period between 2001 and mid-2007, loan growth at large and small banks averaged 8 percent and 6 percent, respectively. Thus, loan growth at large banks in the post-crisis period was reduced in half and those banks account for more than 70 of loans outstanding which translates into a net reduction of bank credit outstanding had these regulations not been in place. As shown in the remaining analysis, the difference in aggregate loan growth between large versus small banks is mainly driven by differences in loan growth of residential mortgages, credit card loans and small business loans.

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Figure 2 shows loan growth of closed-end residential mortgage loans (left panel) and home equity lines of credit (right panel). According to the solid line in the left panel of Figure 2, closed-end mortgage loans rose about 15 percent between the first quarter of 2011 and the second quarter of 2016 at large banks, or less than 3 percent per year, whereas it increased by 35 percent at smaller banks over the past 5 years (dashed line). The subdued growth of mortgage lending at large banks likely reflects tighter mortgage standards at those banks and could explain the decline in first-time homebuyers and homeownership rates observed in the post-crisis period.4 Moreover, the housing sector plays a vital role in the U.S. economy and excessively tight lending standards at banks will widen wealth inequality among households.

As shown on the right panel of Figure 2, the difference between large and small banks is even more pronounced for home equity lines of credit. Such loans increased slightly at small banks since 2011 but have declined over 30 percent at large banks.

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The left panel of Figure 3 depicts the evolution of credit card loan growth. As shown by the dashed line in Figure 3, outstanding credit card loans at small banks nearly doubled since 2011, while such loans increased only slightly at large banks over the same period. That said, large banks still account for most of credit card loans outstanding on banks’ books; as of the second quarter of 2016 large and small banks held $610 billion and $50 billion in credit card loan balances, respectively.

Large banks also account for a sizable share in the provision of credit to small businesses; in 2016:Q2 they accounted for 39 percent of small business loans outstanding.5 As shown in the right panel of Figure 3, small business loan growth at smaller banks outperformed the growth of such loans at large banks over the last 5 1/2 years. However, it is likely that the wedge in small business loan growth between large and smaller banks understates the impact of regulation on the credit availability to small businesses. Specifically, prior to the crisis many small businesses relied on home equity loans to finance new business start-ups and subsequent investments needed to expand their business. As shown in the right panel of Figure 2, home equity loans have steadily declined at large banks since the aftermath of the financial crisis which has further restricted the availability of credit for small businesses.

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1 Martynova, Natalya, “Effect of Bank Capital Requirements on Economic Growth: a Survey,” DeNederlandscheBank, Working Paper No. 467, March 2015.

2 See, “2015 Small Business Credit Survey, Report on Employer Firms,” Federal Reserve Banks of New York, Atlanta, Boston, Cleveland, Philadelphia, Richmond and St. Louis, March 2016.

3 The sample also includes stand-alone commercial banks which are not a subsidiary of a bank holding company.

4 See,, Table 14a. Quarterly Seasonally Adjusted Homeownership Rates in the U.S.

5 According to the most recent Community Reinvestment Act data large banks accounted for 54 percent of small business loan originations.