Enforcing the 1988 Basel Capital Requirements: Did it Curtail Bank Credit in Emerging Economies?

We examine whether the enforcement of bank capital asset requirements (CARs) curtailed the supply of credit in emerging economies. Preliminarily, we identify 16 emerging economies that – according to official and impartial reports – enforced the 1988 Basel standard during the 1990s. Then we perform our twofold econometric analysis. In the former part, we use macro data to test whether, controlling for economic fundamental variables, the enforcement brought about a slowdown in aggregate credit in these countries vis‐a‐vis other emerging economies. We find some support for our hypothesis. In the latter part, we employ individual bank data to better identify the ‘capital crunch’ effect of the enforcement. Here, we find that CAR enforcement – according to the 1988 Basel standard – significantly curtailed credit supply, particularly at less well‐capitalized banks. The two empirical parts together suggest that the CAR enforcement did curtail aggregate credit in the examined emerging countries and that this result is rooted in the attempt by under‐capitalized banks to reduce their loans. We argue that among developing countries – where banks are often the only source of financial intermediation – the positive effect of higher capital requirements, represented by the reduction of poor quality lending, may be offset by their negative impact on bank liquidity and on the level of economic activity. Hence, our results suggest that particular care is required to avoid potential negative macroeconomic effects when phasing in new and higher capital requirements in emerging economies. (J.E.L.: G18, G21, G28)