IMF finds link between bank leverage and corporate lending

Bernard Kellerman
The International Monetary Fund has published an "IMF Working Paper" posing the question: 'How Does Post-Crisis Bank Capital Adequacy Affect Firm Investment?'

The paper looks at the effect of bank capital levels on firm investment, drawing on a sample of more than 11,000 non-financial firms from 2007 to 2013 in 16 advanced economies.

The paper uses two measures of bank capital adequacy: the Tier 1 ratio and a simple leverage ratio. It finds that firms with larger external financial needs invest relatively more when domestic financial systems have relatively high leverage ratios.

This pattern is more pronounced for firms with sound fundamentals, suggesting that bank balance sheets and their willingness to extend credit can be an important factor in determining aggregate investment and growth outcomes.

"The empirical findings are robust to a range of specifications. Bank Tier 1 capital ratio does not appear to have a significant effect on corporate investment, possibly because a higher Tier 1 ratio also captures a high share of assets with low risk weights," the IMF suggests.

While both the Tier 1 ratio and the leverage ratio are good indicators of capital adequacy, they have different implications for investment. The Tier 1 ratio likely biases bank's asset holding toward government bonds and away from corporate and household credit (since such lending carries a higher risk weight)."

The full paper is here