The impact of Basel III on lending spreads of banks (Group Alpha) operating in Lebanon?

Abstract

After the financial crisis of 2008, the Basel committee on Banking Supervision announced the Basel III reforms that can increase the quantity, quality, consistency, and transparency of a bank’s capital. Banks can adjust to the regulatory reforms in a number of ways. In this paper, we assume that Lebanese banks seek to pass on any additional costs of meeting regulations by raising the loan rates. The aim of this paper is to study empirically the relationship between capital and lending spreads of banks operating in Lebanon, group alpha. Following the release of Basel III requirements, Lebanese monetary authorities demanded that its banks acquire a Capital Adequacy Ratio (CAR) of at least 12% by the end of 2015, which is higher than the 8% rate demanded by Basel III. Adopting the model proposed by King (2010), we estimate the potential impact of capital regulations imposed by Base III on the lending spreads of Lebanese banks. Every percentage point increase in capital is offset by an x basis/percentage point increase in lending spreads, assuming the return on equity (ROE) and the cost of debt are unchanged. According to King, the higher cost associated with a one percentage point increase in the capital ratio can be recovered by increasing lending spreads by 15 basis points for a representative bank. The estimation results of this study show that the required increase in lending spreads vary across the Lebanese bank population, ranging from 8 basis points to 36 basis points. Based on the results of this study, it is estimated that most of the Lebanese banks will be in compliance with Basel III requirements as of 2015, and some will certainly be in default by 2019.