On The Anatomy of Capital Management: Evidence from a Regulatory Threshold
52 Pages Posted: 18 Sep 2013 Last revised: 3 Oct 2015
Date Written: October 2, 2015
Abstract
In this study, I explore different dimensions of capital management and its potential drivers. I examine banks’ provisioning behavior for bad loans at a regulatory threshold that limits the amount of loan loss allowances in the banks' total regulatory capital. At the threshold, the marginal effect of the loan loss provisions on the total regulatory capital changes whereas the marginal effect on the Tier 1 capital, earnings, and tax duties remains constant. I find a strong impact from the threshold. The banks build higher loan loss provisions further below the threshold and lower provisions further above it. The relative level of the initial Tier 1 capital moderates the management of total regulatory capital. Furthermore, variable compensation and the listing on a major exchange reduce the total capital management activities. These findings provide evidence on the importance of reporting incentives in relation to the total regulatory capital.
Keywords: Banking; capital management; Tier 1; regulatory capital; loan loss provisions; managerial compensation
JEL Classification: G21, G28, M41
Suggested Citation: Suggested Citation