Monetary policy and capital adequacy: the impact on credit supply

Starting with a theoretical overview of the monetary policy transmission mechanism, we investigate the impact of the movement of the Ecb policy interest rates on loan volumes, considering the capital ratios and loan portfolio quality reported in the financial statements of 65 listed banks in the Euro Area, as included in the Datastream bank sector index, with observations in the 2006-2014 period that includes both policy rate increases and decreases. Our results support the fact that lending by large listed Euro Area banks in the period under observation, which included both contractionary and expansionary conventional monetary measures as well as unconventional monetary policy moves, is positively correlated with monetary policy and higher capitalization, measured in terms of Tier 1 and Tier 2 Capital. Non-Performing loans, in contrast, are negatively correlated with volume of loans and this is actually a desirable effect since it means that banks with a worse track record in loan selection capacity increase their loan portfolio less than their more effective peers. Loan demand, measured by Gdp growth and bank size are also positively correlated with loan volume. One of the possible shortcomings of this analysis stems from the characteristics of the sample, i.e. the largest listed banks in the Euro Area are also the most international. Hence it could be that the increases in total assets and in the loan portfolio stem from rises outside the Euro Area and as such are not the desired effect of the conventional an unconventional monetary policies enacted by the Ecb.