The effect of bank capital on lending: Does liquidity matter?

This paper uses a sample of quarterly observations of insured US commercial banks to examine whether the effect of bank capital on lending differs depending upon the level of bank liquidity. We find that the effect of an increase in bank capital on credit growth, defined as growth rate of net loans and unused commitments, is positively associated with the level of bank liquidity only for large banks and that this positive relationship has been more substantial during the recent financial crisis period. This result suggests that bank capital exerts a significantly positive effect on lending only after large banks retain sufficient liquid assets.