By Stéphanie M. Stolz
The year-long consultations on Basel II replicate the overseas approval for capital specifications as a regulatory tool. but, the influence of capital necessities on banks' habit isn't absolutely understood. the purpose of this learn is to give a contribution to this figuring out through answering the next questions: How do banks regulate capital and danger after a rise in capital specifications? How do banks alter their regulatory capital buffer over the enterprise cycle? And, what's the effect of banks' constitution price at the regulatory capital buffer?
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Extra resources for Bank Capital and Risk-Taking: The Impact of Capital Regulation, Charter Value, and the Business Cycle
2 The Empirical Model 41 effects, I include a merger dummy variable, dyMERGER, in the regression equations which is unity in the year a savings bank takes over another bank and zero otherwise. Second, I also include time dummy variables that capture yearspecific macroeconomic effects. Apart from including time dummy variables, I also experiment with including macroeconomic variables directly. As savings banks are the main lenders to local firms, I expect local firm insolvencies to have a negative impact on capital and a positive impact on risk.
This literature argues mainly within a framework of moral hazard in banking in which information asymmetries and deposit insurance shield banks from the disciplining control of depositors. This irresponsiveness of funding costs to the risk of banks gives rise to moral hazard behavior on the part of banks: Merton (1977) shows that banks have an incentive to decrease capital-to-asset ratios and to increase asset risk, thereby increasing the probability that they will default and extract wealth from the deposit insurance system.
The reason for this is that banks with lower charter values have lower expected earnings and are, hence, less able to cushion negative capital shock out of current earnings. Hence, they need to hold higher capital buffers as an insurance against negative capital shocks. If the charter value falls to close to the fixed cost of recapitalization, the relationship is, however, reversed: the incentive to protect charter value is eroded and the optimum capital buffer falls rapidly towards zero. Only in the extreme case when the charter value is close to zero is it optimal for the bank to maximize risk and to transfer as much capital as possible to shareholders.
Bank Capital and Risk-Taking: The Impact of Capital Regulation, Charter Value, and the Business Cycle by Stéphanie M. Stolz