Basel III : Impacts on European banks' lending rates

Abstract

The last financial crisis showed that the implemented regulation was not efficient enough to protect banks from failure. The notable failure of Lehman Brothers also showed the impact that the fall of a systemic financial institution could have on the world market. After analyzing the causes and the consequences of the crisis, the Basel III was launched. This new framework is still implemented on the basis of the previous framework, but improvements have been made. Indeed, the integration of additional capital requirements, liquidity ratios, the leverage ratio, and the macro-regulation per- spective have made the regulation stronger than ever before. The willingness to protect the financial market and maintain a certain stability has caused other un- clear impacts. Effects on profitability, on business activities, and on risk management have often been pointed out by various authors. Nevertheless, the impact of the Basel III capital requirements on the lending rates is not straightforward. Indeed, the indirect relationship between Basel III, the increase of capital levels, and the impact on lending rates have all been linked with the Chami and Cosimano model. This paper makes use of the capital-to-asset ratio to analyze the effect of capital requirements on lending rates. Firstly, this thesis shows that there is a relationship between the capital-to-asset ratio and the implementation of Basel III capital requirements from 2010 to 2016. Since the implementa- tion of Basel III, the average capital-to-assets ratio has increased by one percent in the European banking sector. Secondly, the model shows a relationship between the increase of the capital-to-as- sets ratio and the lending rates. According to the results of the study, a one percent increase of capi- tal-to-asset ratio increases banks' optimal lending rates by 55 basis points (according to Table 1.2). In other words, this study supports the theoretical assumption that defends the idea that an increase of banks' capital requirements will increase the lending rates.