How Does Bank Equity Affects Credit Creation? The Multiplier Effects under Basel III Regulations

Both equity and regulation play key roles in determining the ability of credit creation of banks. The equity endogenously varies while the regulations are exogenously imposed. I propose a banking model to investigate how the changes in bank equity due to interest receipt and expenditure affect credit and money creation under the Basel III regulations. Three Basel III regulations are discussed: the capital adequacy ratio, liquidity coverage ratio, and net stable funding ratio. The effects on credit creation are demonstrated by the changes in credit supply in response to the interest payments changing the equity. I point out six regulatory scenarios under the three regulations. In each scenario, the changes in equity cause a multiplier effect on the credit supply. And I present a corresponding multiplier effect on money supply. This study sheds new light on how bank equity and Basel III regulations affect credit and money creation