Bank Capital: Lessons from the Financial Crisis

Using a multicountry panel of banks, we study whether better capitalized banks experienced higher stock returns during the financial crisis. We differentiate among various types of capital ratios: the Basel risk‐adjusted ratio, the leverage ratio, the Tier 1 and Tier 2 ratios, and the tangible equity ratio. We find several results: (i) before the crisis, differences in capital did not have much impact on stock returns; (ii) during the crisis, a stronger capital position was associated with better stock market performance, most markedly for larger banks; (iii) the relationship between stock returns and capital is stronger when capital is measured by the leverage ratio rather than the risk‐adjusted capital ratio; (iv) higher quality forms of capital, such as Tier 1 capital and tangible common equity, were more relevant.     

Effectiveness of Capital Regulation at U.S. Commercial Banks, 1985 to 1994

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 deposit-insurance 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.     

Crises,Liquidity Shocks,and Fire Sales at Commercial Banks

If liquidity shortages cause financial crises, a lender of last resort can provide funds to banks facing potential fire sales. However, if funding problems primarily occur at banks with existing solvency problems, then government liquidity programs may not spur bank lending. We find that commercial bank funding does not typically dry up in a crisis, not even during the subprime crisis. Rather, weak banks are more likely to borrow less. Furthermore, banks rely more on deposits and newly issued equity than fire sales. When they do sell assets, they cherry pick assets in order to alleviate pressure from capital regulations.     

Bank Taxes,Leverage, and Risk

We use staggered changes in the taxation of banks by U.S. states to show how banks adjust their capital structure in response to taxes. A one percentage point increase in the income tax rate leads to a decrease in the ratio of equity to total assets of 15 basis points. The effect is symmetric for tax increases and decreases but heterogeneous in that small and strongly capitalized banks react more. In response to taxes, banks also adjust their assets consistent with regulatory arbitrage activities intended to keep down regulatory risk measures, thereby keeping regulatory ratios at acceptable levels despite increasing leverage. Finally, higher taxes may decrease banks’ ability to survive crises.     

Examining the Relationships between Capital,Risk and Efficiency in European Banking

This paper analyses the relationship between capital, risk and efficiency for a large sample of European banks between 1992 and 2000. In contrast to the established US evidence we do not find a positive relationship between inefficiency and bank risk‐taking. Inefficient European banks appear to hold more capital and take on less risk. Empirical evidence is found showing the positive relationship between risk on the level of capital (and liquidity), possibly indicating regulators' preference for capital as a mean of restricting risk‐taking activities. We also find evidence that the financial strength of the corporate sector has a positive influence in reducing bank risk‐taking and capital levels. There are no major differences in the relationships between capital, risk and efficiency for commercial and savings banks although there are for co‐operative banks. In the case of co‐operative banks we do find that capital levels are inversely related to risks and we find that inefficient banks hold lower levels of capital. Some of these relationships also vary depending on whether banks are among the most or least efficient operators.     

Capital ratios and bank lending: A matched bank approach

This paper examines the impact of bank capital ratios on bank lending by comparing differences in loan growth to differences in capital ratios at sets of banks that are matched based on geographic area as well as size and various business characteristics. We argue that such comparisons are most effective at controlling for local loan demand and other environmental factors. For comparison we also control for local factors using MSA fixed effects. We find, based on data from 2001 to 2011, that the relationship between capital ratios and bank lending was significant during and shortly following the recent financial crisis but not at other times. We find that the relationship between capital ratios and loan growth is stronger for banks where loans are contracting than where loans are expanding. We also show that the elasticity of bank lending with respect to capital ratios is higher when capital ratios are relatively low, suggesting that the effect of capital ratio on bank lending is nonlinear. In addition, we present findings on the relationship between bank capital and lending by bank size and loan type.     

我国商业银行资本充足率与风险资产关系研究

资本充足率管理是商业银行风险管理的核心。本文构建了反映我国商业银行资本充足率和风险资产关系的模型,对我国商业银行资本充足率和风险资产之间的关系进行分析。结果发现:商业银行资本充足率的变化会引起资本结构的变化,从而对风险资产产生影响。风险资产的变化又会对资本充足率产生影响。商业银行资本充足率与风险资产这种相互影响的关系为商业银行风险资产管理提供了理论依据。     

Statement of the Financial Economists Roundtable: Bank Capital as a Substitute for Prudential Regulation

The Financial CHOICE Act recently passed by the House proposes to create an “off‐ramp” that would allow banks to escape burdensome prudential regulation if the ratio of their equity capital to their total assets is 10% or more. The Financial Economists Roundtable supports this idea as a means of reducing regulatory costs, but believes some additional safeguards are needed. A capital ratio of 10% may not be high enough to discourage banks from excessive risk taking. A solution is to have two capital requirements for banks choosing the off‐ramp: one absolute (as proposed in the act) and one risk‐based. The FER believes that many banks will prefer this regime to the current burdensome prudential regulation, especially if regulators simplify the setting of risk weights and make them more rule‐based. Regulators setting minimum capital requirements should consider not only a bank’s stand‐alone risk, but also the systemic risk posed by banks, as well as the tendency of accounting measures of income and assets to overstate the economic value of banks’ equity capital. The Financial Choice Act would also eliminate useful elements of ongoing supervision and regulation, not all of which can be addressed by higher capital alone. Furthermore, to facilitate regulatory learning about risks, off‐ramped banks should continue to report the data that regulators use for stress tests, even if they are no longer subjected to the discipline of stress tests. Finally, the act is viewed as too permissive in its treatment of off‐ramped banks that get into trouble. To prevent gaming of regulation, FERC recommends that off‐ramped banks that subsequently fall below the minimum requirements should be required to raise new capital immediately.     

Time‐Varying Capital Requirements and Disclosure Rules: Effects on Capitalization and Lending Decisions

We investigate how banks’ capital and lending decisions respond to changes in bank‐specific capital and disclosure requirements. We find that an increase in the bank‐specific regulatory capital requirement results in a higher bank capital ratio, brought about via less asset risk. A decrease in the requirement implies more lending to firms but also less Tier 1 capital and higher bank leverage. We do not observe differences between confidential and public disclosure of capital requirements. Our results empirically illustrate a tradeoff between bank resilience and a fostering of the economy through more bank lending using banks’ capital requirement as policy instrument.     

Financial factors and firm growth: evidence from financial data on Taiwanese firms

We investigate the possible predictability of firm growth in Taiwan using cross-sectional data of financial factors for the years 1997 and 2003 via principal component analysis. Our results reveal that the 18 financial variables (sales growth rate, total assets, total sales, return on assets, return on equity, gross margin, operating cost minus depreciation divided by sales plus other trading income, acid test ratio, debt–equity ratio, time interest earned, average receivables per average daily sales, inventory, average payables per average daily sales, working capital, working capital as a fraction of total assets, long-term liabilities as a fraction of total assets, and sales as a fraction of net worth of the firm) that we employ bunch together into five different financial ratios for the years 1997 and 2003 that are stable between these years. These financial factors are short-term liquidity, return on investment, long-term liquidity, firm size and capital turnover. Regressing these ratio groups (extracted principal components) on firm growth, we find return on investment in the year 1997 was positively and significantly related to firm growth, while long-term solvency was negatively related to firm growth. In addition, smaller firms tended to grow faster. By 2003, larger firms grew faster than smaller ones and short-term liquidity was positively and significantly related to firm growth, while return on investment was no longer a significant determining factor. Our findings suggest that firms that finance internally or do not rely too heavily on indebtedness may end up growing slower during boom periods but they are the ones that survive and outperform after the bust.     

Capital changes at large affiliated banks

The federal bank regulators imposed numerical capital guidelines in December 1981. If these guidelines are binding, then banking organizations may respond to the costs of regulation in various ways. If the regulations are not binding, then further reliance may be placed on market discipline. This study develops two models of changes in the equity capital to assets ratio of large banks affiliated with bank holding companies—a regulatory model in which capital regulations are a binding influence and a market model in which financial markets influence capital ratios. The two models are examined empirically through a disequilibrium framework and maximum likelihood estimation techniques. The results suggest that most banks are predominantly influenced by regulatory forces. Federal Reserve Bank of Atlanta Florida State University     

Capital Constraints,Asymmetric Information,and Internal Capital Markets in Banking: New Evidence

A growing literature investigates the role of internal capital markets in mitigating financial constraints faced by the subsidiaries of a conglomerate. Most studies have relied on indirect tests based on correlations between the cash flows and the investment of the subsidiaries. In contrast, we avoid the widespread criticisms of such specifications by providing direct tests that focus on the mechanisms through which internal reallocations of funds occur. We find that internal capital markets are used by multibank holding companies to mitigate capital constraints faced by individual bank subsidiaries. In addition, we show that internal capital management within a multibank holding company involves not only the movement of capital to those subsidiaries with a relatively greater need for capital but also the movement of assets (loans) from less well capitalized to better capitalized subsidiaries by means of loan sales and purchases among the subsidiaries. Furthermore, net loan sales are used to allow efficiency‐enhancing specialization among bank subsidiaries, insofar as those subsidiaries with the best loan origination opportunities are able to focus on loan originations even if they do not have sufficient capital to hold the loans. Our evidence is consistent with banks affiliated with holding companies more actively participating in loan sales and purchases because, by using their internal secondary loan market, they are able to avoid the “lemons” problem faced by stand‐alone banks.     

Book‐to‐Market Equity,Asset Correlations and the Basel Capital Requirement

This paper examines the effect of book‐to‐market equity (BE/ME) on asset correlations under the Basel capital requirement. We find that BE/ME captures variations in asset correlations after controlling for firm size, default probability and industry effects from 1987 to 2011. Obligors with higher BE/ME exhibit lower asset correlations compared to those with lower BE/ME. Decomposing BE/ME into assets‐in‐place and growth options based on the asset pricing literature shows that obligors with more assets‐in‐place or more fixed assets have higher BE/ME and lower asset correlations than those with more growth options. Overall, our findings suggest that BE/ME is an additional important factor that may improve the estimates of asset correlations and thereby banks’ capital adequacy.     

Have SFAS 166 and SFAS 167 improved the financial reporting for securitizations?

Critics have alleged that securitization accounting prior to 2010 was among the causes of the recent financial crisis. In response to this criticism, the Financial Accounting Standards Board (FASB) implemented two new accounting standards, SFAS 166 and SFAS 167, to improve the financial reporting for securitizations. Bank regulators have stated their belief that SFAS 166/167 will result in a consolidated balance sheet (and risk-based capital ratios based thereupon) that better reflects a bank's exposure to risk related to securitized assets. We document that, by ceding retained power or influence through the servicing/special servicing functions to third parties, SFAS 166/167 resulted in real effects to the extent that banks (particularly those that were weakly capitalized) achieved their accounting objectives in the post-SFAS 166/167 period through legitimate transaction structuring in line with the intent of the new rules. Further, we use capital market participants’ assessments of risk retention by sponsoring banks as a benchmark, and provide evidence consistent with bank regulators’ beliefs. In particular, following SFAS 166/167, equity investors of sponsoring banks do not consider (consider) as risk relevant securitized assets that receive off-balance sheet (on-balance sheet) treatment. Securitized assets that are consolidated under SFAS 166/167 exhibit the same risk relevance as assets that are not securitized, despite contractual provisions that would seem to imply substantial risk transfer.     

Deposit Insurance, Capital Adequacy Requirements and Interest Rate Dynamics

This paper examines the long run interaction among deposit insurance, bank deposit rates and capital adequacy requirements. Using analysis similar to the price discrimination model of Lott and Roberts (1991) we find that a competitive environment among banks would link the spread between insured and uninsured deposit rates to the size of the insurance premium. We also find that banks that choose to operate at the regulatory minimum capital level, would increase asset risk with increased capital requirements if (1) the implicit interest paid to insured and uninsured depositors is equally sensitive to changes in risk and capital adequacy and (2) the insurance premium is independent of the level of risk and capital adequacy. Under the present risk-based premium structure, asset risk has the potential to decline when the regulatory agency raises capital requirements. Finally, we examine the time series behavior of insured and uninsured interest rates to see if it is consistent with our theoretical model. We find that insured and uninsured rates, along with deposit insurance premiums, are cointegrated series as suggested by our model.     

Capital Adequacy, Bank Mergers, and the Medium of Payment

We examine how banks' capital requirements affect the way bank mergers are financed, as well as the stock-market reaction to the merger announcement. We find that the capital position of the acquirer is one of the two factors most strongly influencing the choice of financing method; the other is the relative size of the merging banks. The smaller the acquirer in relation to the target bank and the higher the acquirer's capital adequacy ratio, the more likely it is that the acquisition will be financed by a stock swap. The capital requirements also affect the market reaction, through their effect on the financing method choice. The value of the acquirer's equity decreases more at the time of the merger announcement if the method of payment is stock. Like prior studies, we find that the abnormal return on the target banks' stock is positive.     

外资股权、外币资产负债结构对我国银行稳定性影响的研究

目前,国际资本流动影响我国银行稳定性主要通过两条路径：一是通过持有我国商业银行股权,二是通过改变商业银行的资产负债结构。本文运用15家股份制商业银行2006—2012年面板数据,从微观角度探讨了外资股权结构、外币资产负债结构对其稳定性造成的影响。实证结果表明：（1）外资股权对商业银行稳定性影响在不同银行之间存在着一定差异;（2）外币资产负债结构对于我国商业银行稳定性有明显影响。据此,本文从外资股权、外币资产负债结构方面提出了商业银行稳定性管理的建议。     

Bank Capital Requirements, Capital Structure and Regulation

This paper studies the impact of capital requirements, deposit insurance and franchise value on a bank’s capital structure. We find that properly regulated banks voluntarily choose to maintain capital in excess of the minimum required. Central to this decision is both firm franchise value and the ability of regulators to place banks in receivership stripping equity holders of firm value. These features of our model help explain both the capital structure of the large mortgage Government Sponsored Enterprises and the recent increase in risk taking through leverage by financial institutions. The insights gained from the model are useful in guiding the discussion of financial regulatory reforms.     

MARKET REACTION TO NATIONAL DISCRETION IN IMPLEMENTING THE BASLE ACCORD

We report the wealth effects among banks in the United States, Japan, Canada, and the United Kingdom in reaction to public announcements concerning their respective national implementation of the 1988 Basle Accord, an international risk-based capital regulatory agreement. Previous survey findings indicate bankers in different countries perceive that national discretion could threaten the competitive equity goals of the new risk-based capital rules. Based on a multivariate regression model using seemingly unrelated equations, we find significantly positive and negative market reactions by bank investors to individual announcements of different countries' post-Accord capital rules. However, no particular country's banks were systematically advantaged or disadvantaged with national discretion announcements viewed in aggregate. Although national discretion does affect bank wealth, the evidence does not suggest that national implementation compromises the competitive goals of the Accord.     

Do different forms of government ownership matter for bank capital behavior? Evidence from China

This study attempts to reconcile the conflicting theoretical predictions regarding how government ownership affects bank capital behaviour. Using a unique Chinese bank dataset over 2006–2015 we find that government-owned banks have higher target capital ratios and adjust these ratios faster compared to private banks, supporting the ‘development/political’ view of the government’s role in banking. This effect is stronger for local government-owned and state enterprise-owned banks than for central government-owned banks. We also find that undercapitalized government-owned banks increase equity while undercapitalized foreign banks contract assets and liabilities as their respective main strategy to adjust their capital ratios.