Unpacking the impact of the capital requirement regulation on non-performing loan dynamics in EU banks

In the wake of the global financial crisis, an increasing trend in non-performing loans has led to significant risks to financial stability . The 2014 Capital Requirements Regulation was introduced to tackle systemic vulnerabilities in the banking sector by setting an 8% risk-weighted capital requirement. This study demonstrates that stricter capital regulation increases the costs of holding risky assets, especially non-performing loans. This regulatory intervention also reduced the growth in the non-performing loan ratio. The study shows that the effect’s magnitude depends on the bank’s size and the extent of the non-performing loans held before the regulation. Finally, the regulatory impact continued for four years, gradually diminishing post-implementation. • NPLs increased after the global financial crisis, raising risks for European banks. • Stricter capital rules made holding risky assets like NPLs more costly for banks. • NPL growth dropped sharply following the introduction of the new regulation. • Larger banks with higher NPL levels were most impacted by the regulation. • The regulatory impact lasted four years, diminishing post-implementation.