Quantifying and Explaining Parameter Heterogeneity in the Capital Regulation-Bank Risk Nexus
Posted: 22 May 2009 Last revised: 30 Jul 2012
Date Written: November 10, 2009
Abstract
By examining the impact of capital regulation on bank risk-taking using a local estimation technique, we are able to quantify the heterogeneous response of banks towards this type of regulation in banking sectors of western-type economies. Subsequently, using this information on the bank-level responses to capital regulation, we examine the sources of heterogeneity. The findings suggest that the impact of capital regulation on bank risk is very heterogeneous across banks and the sources of this heterogeneity can be traced into both bank and industry characteristics, as well as into the macroeconomic conditions. Therefore, the present analysis has important implications on the way bank regulation is conducted, as it suggests that common capital regulatory umbrellas may not be sufficient to promote financial stability. On the basis of our findings, we contend that Basel guidelines may have to be reoriented towards more flexible, country-specific policy proposals that focus on the restraint of excess risk-taking by banks.
Keywords: Capital regulation, risk-taking of banks, local generalized method of moments
JEL Classification: C14, C33, G21, G32, G38
Suggested Citation: Suggested Citation