This paper examines whether or not bank banks charge higher loan spreads for maintaining high capital ratios. This is an important question as, since the mid-1990s, capital ratios in U.S. banking organizations have substantially exceeded even the highest supervisory standards (so-called ”capital buffer”). Berger et al. (2008) document that ”as of June 2007, the 67 BHCs with assets exceeding 10 billion had a mean Tier 1 leverage ratio of 7.63%, a Tier 1 risk-based ratio of 9.38%, and a total risk-based capital ratio of 11.97%”. Yet, only few studies shed light on the role of bank capital on the costs of corporate debt1.

If banks price high capital ratios into loan spreads, as we find, it is an interesting question to ask whether loans are priced differently for transparent versus opaque firm with respect to this loan spread component. As argued in Rajan (1992), banks might be able to charge higher loan spreads to informationally opaque firms which lack alternative outside funding options and thereby ’hold-up’ the borrower. If higher loan costs induced by high capital ratios are simply an artifact of hold-up, this higher spread can be competed away at least for informationally transparent firms. However, if loans are not priced differently for opaque versus transparent firms and also competition among banks does not lower the costs of corporate borrowing, then the effect identified in this paper might well explain why loan costs are higher in the U.S. relative to Europe (Carey and Nini, 2007).