The macroeconomic impact of bank capital requirements in emerging economies: Past evidence to assess the future

We test for emerging economies the hypothesis - previously verified for G-10 countries only - that the enforcement of bank capital asset requirements (CARs) curtails the supply of credit. The econometric analysis on individual bank data suggests three main results. First, CAR enforcement significantly trimmed credit supply, particularly at less-well capitalized banks. Second, the negative impact has been larger for countries enforcing CARs in the aftermath of a currency/financial crisis. Third. the adverse impact of CARs has been somewhat smaller for foreign-owned banks, suggesting that opening up to foreign investors may have partly shielded the domestic banking sector from negative shocks. Overall, CAR enforcement - inducing banks to reduce their lending - may have had both beneficial and detrimental effects. On one hand. it may have reduced ill-advised lending - possibly induced by banks' exploitation of the public safety net - and this is desirable. On the other hand. CAR enforcement may have induced an aggregate credit slowdown or contraction in the examined emerging countries, thus exacerbating liquidity constraints and negatively affecting real activity. This paper is relevant to the ongoing debate on the impact of the revision of bank CARs. as contemplated by the new Basel proposal. Our results suggest that in several emerging economies the revision of bank CARs could well induce a credit supply retrenchment, which should not be underestimated. (C) 2002 Elsevier Science B.V. All rights reserved.