Do Capital Requirements Make Banks Safer? Evidence From a Quasi-Natural Experiment
37 Pages Posted: 7 Oct 2017 Last revised: 5 Jan 2021
Date Written: January 3, 2021
Abstract
We use the EBA capital exercise of 2011 as a quasi-natural experiment to investigate how capital requirements affect various measures of bank solvency risk. We show that, while regulatory measures of solvency improve, non-regulatory 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.
Keywords: Capital requirements, regulation, banks, risk, Basel III
JEL Classification: G01, G21, G28
Suggested Citation: Suggested Citation