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Do Capital Requirements Make Banks Safer? Evidence From a Quasinatural Experiment

Published online by Cambridge University Press:  10 September 2021

Denefa Bostandzic ,
Felix Irresberger Open the ORCID record for Felix Irresberger [Opens in a new window] ,
Ragnar E. Juelsrud  and
Gregor Weiß
Denefa Bostandzic
Affiliation:
Universität Witten/Herdeckedenefa.bostandzic@uni-wh.de
Felix Irresberger
Affiliation:
Durham University Business Schoolfelix.irresberger@durham.ac.uk
Ragnar E. Juelsrud*
Affiliation:
Norges Bank
Gregor Weiß
Affiliation:
Universität Leipzigweiss@wifa.uni-leipzig.de
*
ragnar@juelsrud.no (corresponding author)
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Abstract

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We use the EBA capital exercise of 2011 as a quasinatural experiment to investigate how capital requirements affect various measures of bank solvency risk. We show that, while regulatory measures of solvency improve, nonregulatory measures indicate a deterioration in bank solvency in response to higher capital requirements. The decline in bank solvency is driven by a permanent reduction in banks’ market value of equity. This finding is consistent with a reduction in bank profitability, rather than a repricing of bank equity due to a reduction of implicit and explicit too-big-too-fail guarantees. We then discuss alternative policies to improve bank solvency.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 57 , Issue 5 , August 2022 , pp. 1805 - 1833
Creative Commons
Creative Common License - CCCreative Common License - BY
This is an Open Access article, distributed under the terms of the Creative Commons Attribution licence (https://creativecommons.org/licenses/by/4.0/), which permits unrestricted re-use, distribution, and reproduction in any medium, provided the original work is properly cited.
Copyright
© The Author(s), 2021. Published by Cambridge University Press on behalf of the Michael G. Foster School of Business, University of Washington

Footnotes

We thank an anonymous referee and Paul Malatesta (the editor) for their insightful and constructive feedback. We thank Takuji Arai, Martin Holm, Daniel Kinn, Daisuke Nagakura, Teruo Nakatsuma, Plamen Nenov, and Ella Getz Wold, and seminar participants at BI Norwegian Business School and Keio University for useful comments, discussions, and suggestions. Weiß gratefully acknowledges financial support from the Fritz Thyssen Stiftung as well as the Commerzbank Stiftung. We have no potential conflicts of interest. This article should not be reported as representing the views of Norges Bank. The views expressed are those of the authors and do not necessarily reflect those of Norges Bank.

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