Resuming bank lending in the aftermath of the Capital Purchase Program

In the second half of 2008, after a series of bankruptcies of large financial institutions, the U.S. Treasury poured capital infusions into domestic financial institutions under the Capital Purchase Program (CPP), thus helping to avert a complete collapse of the U.S. banking sector. In this article the effectiveness of the Capital Purchase Program is analysed in terms of restoring banks' loan provisions. The relative impacts of liquidity shortages (which negatively affected banks' willingness to lend) and the contraction in aggregate demand for bank loans are examined. The empirical evidence on the effects of capital shortages supports the theory. Banks that have a higher level of capitalisation tend to lend more both during the crisis and in normal times. Moreover, it is found that bailed-out banks displayed higher growth rates of loans during the crisis than in normal times (before 2008) as well as higher rates compared with non-bailed banks during the crisis, with a one percentage point increase in the capital ratio. In addition, bailed-out banks that repurchased their shares from the U.S. Treasury provided more loans during the crisis than those banks that did not.