The impact of capital-based macroprudential policy on banks’ balance sheet composition

We assess the effects of capital-based macroprudential policy on the composition of banks’ balance sheets. Employing a bank-level panel vector autoregressive model incorporating 188 macroprudential actions across 30 European countries, we analyze the impact of regulatory changes on banking variables while accounting for endogeneity. The results indicate that macroprudential policy shocks positively affect the common equity tier 1 ratio, prompting banks to adjust their asset allocations from higher-risk loans to safer, more liquid assets, thereby reducing risk-weighted assets and increasing the capital ratio. Additionally, regulators demonstrate proactive behavior by raising capital requirements in response to heightened bank lending and profitability. Policymakers should be cautious, as additional capital requirements may lead banks to strengthen their capital positions by reducing risk-weighted assets, potentially diminishing lending and adversely affecting banking profitability and real economy.