The macroeconomic impact of changes in economic bank capital buffers Prepared by Derrick Kanngiesser, Reiner Martin, Diego Moccero and Laurent Maurin

4 The macroeconomic impact of shocks to economic bank capital buffers
The evolution of bank lending volumes and spreads in the four countries under consideration suggests that economic bank capital buffers may have played an important role in shaping these variables (see Charts 1 and 2). In particular, mortgage and corporate lending decelerated substantially during the international financial crisis and then again during the euro area sovereign debt crisis. In both periods, bank lending spreads widened. As a result of the collapse in bank lending and soaring bank lending spreads, economic activity deteriorated. The concomitant decline in economic bank capital buffers, which capture constraints in the ability of banks to provide lending to the economy, offers prima facie evidence of the potential impact of changes in economic bank capital buffers on macroeconomic and banking variables.
However, the simple evolution of the variables in Charts 1 and 2 does not allow the disentangling of the particular drivers of bank lending and lending spreads. On the one hand, the drop in bank lending growth coincided with an economic downturn, pointing to demand factors affecting lending. On the other hand, it is likely that the decline in bank capital buffers led banks to curtail lending to households and corporations and to increase lending spreads. More expensive and less buoyant lending then contributed to the further slowdown observed in economic activity and inflation. As such, a macroeconometric model is needed to disentangle the impact of shocks to economic banks’ capital buffers from other sources of variation in bank lending and lending spreads.
We use a panel Bayesian VAR model to quantify the impact of changes in bank capital buffers on banking variables and the macroeconomy in the four euro area countries.^[8^] The starting point in the analysis is the standard VAR model used extensively in monetary policy analysis (including the monetary policy interest rate, economic activity and inflation), extended to include aggregate banking variables (bank lending volumes and spreads) on top of the country-level bank capital buffers.^[9^] Based on this model, it is possible to estimate the response of the variables to a negative shock in bank capital buffers, i.e. a decline in actual capital ratios below the target value.^[10^]