Bank capital, lending booms, and busts. Evidence from Spain in the last 150 years

In this paper we analyze the effect of bank capital on lending expansion and contraction for nearly 150 years in Spain. We fi rst build up thoroughly a measure of bank leverage (i.e. the capital to assets ratio) for the Spanish banking sector starting in year 1880. Then, we run a proper econometric test to analyze the impact that bank capital levels have on lending cycles, controlling for other determinants of credit growth. We do fi nd robust empirical evidence of an asymmetric relationship between bank capital and credit cycle. In particular, an increase in the bank capital before expansions reduces credit growth while it increases credit growth when the recession arrives. Conversely, a too depleted level of bank capital when entering in a recession has a severe impact on lending (i.e. may bring about a deep credit crunch) with quite negative and lasting effects in the economy and the wellbeing of the society as a whole. The paper is particularly useful to support macroprudential policies (dynamic provisions and the countercyclical capital buffer) that have been very recently put in place as they will help to smooth the credit cycle. The experience of Spain over more than a century, with very marked lending cycles, provides a fertile ground for analyzing and supporting them, not only based on the last lending cycle, but also on those occurred in the more distant past.