The Impact of Capital on Lending in Economic Downturns and Investor Protection - the Case of Large EU Banks

Abstract

This paper attempts to find out whether better quality of investor protection
matters for the effect of capital ratio on loan growth of large EU banks in 1996-
2011. We focus on several measures of the quality of investor protection with
a proven track record in the banking literature, i.e.: anti-self-dealing index,
ex-ante-control and ex-post-control of anti-self-dealing indices, and creditor
protection rights index. Our results show that better investor protection
decreases the procyclical impact of capital on lending. This effect is statistically
significant for the ex-post-control index. This is consistent with the view
that better shareholders rights reduces bank risk-taking, in particular during
economic booms, which results in weakened sensitivity of bank lending to capital
ratios in economic downturns. This effect holds for both unconsolidated and
consolidated data and is robust to sensitivity checks.