To use or not to use? Capital buffers and lending during a crisis

In this paper, we study the effect of having a greater management capital buffer on banks’ lending during a crisis. Using loan-level data merged with detailed supervisory data on banks’ balance sheets and regulatory requirements, we find that Portuguese banks with greater headroom above the overall capital requirement lent more to firms after the Covid-19 shock than banks with lower headroom, i.e., banks used, at least to some extent, their management buffers. The introduction of public-guarantee schemes in this period mitigated this effect as banks with lower capital headroom had the incentive to lend under these schemes. Moreover, we find that the effect of management buffer on lending is stronger for banks with lower market funding and more vulnerable firms, highlighting the importance of market pressure and risk aversion, respectively.