Banks' capital structure and capital regulations

Okahara, Naoto (2018): Banks' capital structure and capital regulations.

Abstract

This study proposes a model that describes banks' decisions about their capital structures and analyzes the effects of regulating banks' capital adequacy ratios (CAR); that is, the ratio of equity financing to risky assets. This study investigates whether bank lending decreases when the banks need to raise their CAR to satisfy the regulation. We analyze a model in which households have bargaining power regarding deposits and a bank must adjust its capital structure indirectly through the households' decision-making, and compare the results which that obtained in a model in which the bank has the bargaining power. In either case, the bank can suffer a loss when it raises its CAR. However, changes in the amount of lending in the two models differ. When the bank has the bargaining power, it always chooses to just use equity financing more, and thus there is no probability that bank lending decreases. When the households has the bargaining power, contrariwise, this model shows that the more risk-averse households are, the more likely the amount of lending is to decrease. These results can explain why banks' reaction to the CAR regulation are different from each other. Moreover, the results indicate a positive probability that regulating banks' capital structures has a negative effect on the economy.

• Item Type: MPRA Paper
• English Title: Banks' capital structures and capital regulations
• Language: English
• Keywords: Bank capital, Bank lending, Capital regulation
• Subjects: E - Macroeconomics and Monetary Economics > E1 - General Aggregative Models > E10 - General; G - Financial Economics > G1 - General Financial Markets > G18 - Government Policy and Regulation; G - Financial Economics > G2 - Financial Institutions and Services > G21 - Banks ; Depository Institutions ; Micro Finance Institutions ; Mortgages

References

Acharya, Viral and Anjan Thakor, 2016. The dark side of liquidity creation: Leverage and systemic risk. Journal of Financial Intermediation, 28, 4–21.

Acharya, Viral, Hamid Mehran, and Anjan Thakor, 2016. Caught between scylla and charybdis? Regulating bank leverage when there is rent seeking and risk shifting. Review of Corporate Finance Studies, 5 (1), 36–75.

Admati, Anat, Peter DeMarzo, Martin Hellwig, and Paul Pfleiderer, 2014. Fallacies and Irrelevant Facts in the Discussion on Capital Regulation. in: Goodhart, Charles, Daniela Gabor, Jakob Vestergaard, and Ismail Erturk. (Eds.), Central Banking at a Crossroads: Europe and Beyond, London; New York, NY: Anthem Press, Chap. 3, 33–50.

Aiyar, Shekhar, Charles Calomiris, and Tomasz Wieladek, 2015. Bank capital regulation: Theory, empirics, and policy. IMF Economic Review, 63 (4), 955–983.

Allen, Franklin, Elena Carletti, and Robert Marquez, 2015. Deposits and bank capital structure. Journal of Financial Economics, 118 (3), 601–619.

Ben Naceur, Sami, Katherin Marton, and Caroline Roulet, 2018. Basel III and bank-lending: Evidence from the United States and Europe. Journal of Financial Stability, 39, 1–27.

Berger, Allen, Robert DeYoung, Mark Flannery, David Lee, and Ozde Oztekin, 2008. How do large banking organizations manage their capital ratios?. Journal of Financial Services Research, 34 (2-3), :123–49.

Bhattacharyya, Sugato and Amiyatosh Purnanandam, 2011. Risk-taking by banks: What did we know and when did we know it?. AFA 2012 Chicago Meetings Paper.

Calomiris, Charles and Charles Kahn, 1991. The role of demandable debt in structuring optimal banking arrangements. American Economic Review, 81 (3), 497–513.

Carlson, Mark, Hui Shan, and Missaka Warusawitharana, 2013. Capital ratios and bank lending: A matched bank approach. Journal of Financial Intermediation, 22 (4), 663–687.

Chen, Yehning, 2016. Bank capital and credit market competition: Will competitive pressure lead to higher capital levels?. Journal of International Money and Finance, 69, 247–263.

Coval, Joshua and Anjan Thakor, 2005. Financial intermediation as a beliefs-bridge between optimists and pessimists. Journal of Financial Economics, 75, 535–569.

DeAngelo, Harry and Rene Stulz, 2015. Liquid-claim production, risk management, and bank capital structure: Why high leverage is optimal for banks. Journal of Financial Economics, 116 (2), 219–236.

Diamond, Douglas and Philip Dybvig, 1983. Bank runs, deposit insurance, and liquidity. Journal of Political Economy, 91 (3), 401–419.

Jensen, Michael and William Meckling, 1976. Theory of the firm: Managerial behavior, agency costs and ownership structure. Journal of Financial Economics, 3 (4), 305–360.

Kanngiesser, Derrick, Reiner Martin, Laurent Maurin, and Diego Moccero, 2017. Estimating the impact of shocks to bank capital in the euro area. ECB Working Paper (2077).

Keeley, Michael, 1990. Deposit insurance, risk, and market power in banking. American Economic Review, 80 (5), 1183–1200.

Krishnamurthy, Arvind and Annette Vissing-Jorgensen, 2012. The aggregate demand for treasury debt. Journal of Political Economy, 120 (2), 233–267.

Lindquist, Kjersti-Gro, 2004. Banks’ buffer capital: How important is risk. Journal of International Money and Finance, 23 (3), 493–513.

Olszak, Ma lgorzata, Mateusz Pipien, and Sylwia Roszkowska, 2016. The impact of capital ratio on lending of EU banks – the role of bank specialization and capitalization. Equilibrium. Quarterly Journal of Economics and Economic Policy, 11 (1), p. 43.

Repullo, Rafael, 2004. Capital requirements, market power, and risk-taking in banking. Journal of Financial Intermediation, 13 (2), 156–182.

Thakor, Anjan, 2014. Bank capital and financial stability: An economic trade-off or a faustian bargain?. Annual Review of Financial Economics, 6, 185–223.

Van den Heuvel, Skander, 2008. The welfare cost of bank capital requirements. Journal of Monetary Economics, 55 (2), 298–320.