Capital standards of banks and loan supply: Evidence from India

Abstract

This research proposal aims to analyze the impact of risk based capital allocation rules on the asset allocation decision of banks and the consequent impact on supply of bank loans. Risk based capital standards link capital requirement to the risk of the assets held by the financial institution. The risk weights for risky assets such as loans would be higher than the risk weights for low risk assets such as treasury securities. This leads to a higher capital requirement for high risk weighted assets and lower capital requirement for low risk weighted assets. The difference in capital requirements for different assets may provide an incentive for banks to shift from high risk weight to low risk weight assets with the consequence that the supply of high risk weight assets such as loans may be lower with risk based capital standards. This research aims to examine the impact of capital standards on banks loan supply in the Indian context. India is an interesting country to study for the following reasons: (1) it provides an opportunity to examine the impact of capital standards in the country with less developed capital markets with presence of capital constraints, and (2) the presence of the large government owned banks along with the presence of private banks provides us the opportunity to examine if capital constraints are different for the two ownership groups.