This paper studies the transmission of bank capital shocks to loan supply in Indonesia. A
series of theoretically founded dynamic panel data models are estimated and find nonlinear
effects of capital on loan growth: the response of weaker banks to changes in their capital
positions is larger than that of stronger banks. This non-linearity implies that not only the
level of capital but also its distribution across banks in the financial system affects the
transmission of shocks to aggregate lending. Likewise, the effects of bank recapitalization on
loan growth depend on banks’ starting capital positions and the size of capital injections.
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