The Macroeconomic Effects of Bank Capital Requirement Tightenings: Evidence from a Narrative Approach

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Bank capital regulations are intended to enhance financial stability in the long run, but
may, in the meanwhile, involve costs for the real economy. To examine these costs we
propose a narrative index of aggregate tightenings in regulatory US bank capital
requirements from 1979 to 2008. Anticipation effects are explicitly taken into account
and found to matter. In response to a tightening in capital requirements, banks
temporarily reduce business and real estate lending, which temporarily lowers
investment, consumption, housing activity and production. A decline in financial and
macroeconomic risk helps sustain spending in the medium run. Monetary policy also
cushions negative effects of capital requirement tightenings on the economy.

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