Evaluating Risk-Based Capital Regulation

Journal of Finance, 2000

Unless priced and administered appropriately, a governmental safety net enhances risk-shifting opportunities for banks. This paper quantifies regulatory efforts to use capital requirements to control risk-shifting by U.S. banks during 1985 to 1994 and investigates how much risk-based capital requirements and other depositinsurance reforms improved this control. We find that capital discipline did not prevent large banks from shifting risk onto the safety net. Banks with low capital and debt-to-deposits ratios overcame outside discipline better than other banks. Mandates introduced by 1991 legislation have improved but did not establish full regulatory control over bank risk-shifting incentives.

Journal of Banking & Finance, 1989

The paper extends the option-theoretic framework for the estimation of risk-adjusted deposit premiums to the calculation of risk-based capital adequacy standards. Based on market data for equity and the book value of debt, the model solves for the market value of the capital infusion required to lower the implied deposit premium to acceptable levels of risk. This capital infusion can then be translated into market-value capital adequacy standards and book-value capitalasset ratios, the determination of which is within the current statutory discretion of regulatory agencies. The model is empirically applied to a sample of 43 major U,S. banks. *The authors gratefully acknowledge the helpful suggestions and comments of the participants at finance seminars at

SAGE Open

This study aims to examine the impact of different capital ratios on Non-Performing loans, Loan Loss Reserves, and Risk-Weighted Assets by studying large commercial banks of the United States. The study employed a two-step system generalized method of movement (GMM) approach by collecting the data over the period ranging from 2002 to 2018. The study finds that using Non-Performing loans and Loan Loss Reserves as a proxy for risk, results support moral hazard hypothesis theory, whereas the results support regulatory hypothesis theory when Risk-Weighted Assets is used as a proxy for risk. The results confirm that the influence of high-quality capital on Non-Performing loans, Loan Loss Reserves, and Risk-Weighted Assets is substantial. The distinctive signs of Non-Performing loans, Loan Loss Reserves, and Risk-Weighted Assets have indications for policymakers. The results are intimate for formulating new guidelines regarding risk mitigation to recognize Non-Performing loans and Loan Lo...

Journal of Financial Intermediation, 1996

We show that in an imperfect information environment the equity value of an impaired bank may increase or decrease when it is required to meet a capital standard. Regardless of the change in the bank's equity value, however, its stock price will fall in response to a forced recapitalization, consistent with recent empirical evidence. Simulations of our model suggest that this stock price decline is likely to be larger the smaller is the share of ownership held by the managers of the bank, also consistent with recent empirical evidence in the literature. Our model further predicts a rise in bank's non-interest expenses following a required recapitalization. Given the increase in the regulator's exposure that would accompany a reduction in the bank's market value of equity, the regulator may choose not to enforce the regulation. Hence, capital regulation may be timeinconsistent in this situation and consequently not have its intended risk-mitigating incentives.

Journal of Financial Intermediation, 1999

In this paper we model the dynamic portfolio choice problem facing banks, calibrate the model using empirical data from the banking industry for 1984-1993, and assess quantitatively the impact of recent regulatory developments related to bank capital. The model implies a U-shaped relationship between capital and risk-taking: As a bank's capital increases it first takes less risk, then more risk. A deposit insurance premium surcharge on undercapitalized banks induces them to take more risk. An increased capital requirement, whether flat or risk-based, tends to induce more risk-taking by ex-ante well-capitalized banks that comply with the new standard.

Journal of Banking Regulation

The emergence of risk-based capital regulation that is allowing banks to use their internal risk models for regulatory purposes was among the main regulatory developments prior to the financial crisis. During the crisis, it became evident these models underestimated the level of risk. The post-crisis regulatory approach brought a reversal of policy by significantly reducing the scope of risk-based capital regulation and making regulations less risk-sensitive. At first glance, this appears to be a step back toward an antiquated, less sophisticated regulatory regime. This article analyses these two regulatory policy transformations: from less risk-sensitive to risk-based before the crisis and from risk-based to less risk-sensitive subsequently. Its main conclusion is that a mixed regulatory system is superior to either purely non-risk-sensitive or purely risk-based regulation, because a mixed system can help mitigate the negative incentives of both non-risk-sensitive and risk-based re...

International Review of Finance, 2010

Using bank-level panel data from the United Kingdom, this paper investigates the factors that influence banks' choice of risk-based capital ratios. The study focuses on evaluating the role of regulatory capital requirements. Findings indicate that such requirements, even when not binding, affect banks' capital management practices and suggest that banks maintain targeted buffers above regulatory thresholds. That behavior differs across several dimensions, including bank size, nearness to regulatory minimum, reliance on core (equity) capital and exposure to market discipline. Capital ratios also vary over the economic cycle. These findings have implications for the ongoing review of international capital standards.

2007

In recent years, regulators have increased their focus on the capital adequacy of banking institutions to enhance their stability, hence the stability of the whole financial system. The purpose of this paper is to assess and compare how American and European banks adjust their level of capital and portfolio risk under capital regulation, whether and how they react to constraints

Journal of Financial Services Research, 2001

This paper examines banks' capital, portfolio and growth decisions from 1986 to 1995, when risk-based capital guidelines were proposed and implemented. Overall, we observe complementarity between equity financing and risk. We find no systematic differences in pre- and postregulation behavior consistent with banks reacting to risk-based capital standards implementation. We do find significant differences, however, between low-capital banks and other

Journal of Banking & Finance, 1991

The present note provides empirical evidence on the relative competitive effects of the adoption of risk-based capital requirements on large, international banks in the U.S., Canada, U.K., and Japan. A two-index regression model is used to calculate prediction errors in periods with numerous announcements concerning the new capital rules, including the Basle Conference. We lind significant declines in equity returns for U.S., Canadian, and U.K. banks in response to news announcements, with U.S. bank stocks exhibiting the largest negative reaction. For Japanese banks, the equity return results are mixed, which may be due to uncertainty among investors regarding the handling of their sizeable hidden reserves under the new risk-adjusted capital rules.