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Banks' capital structure and capital regulations

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

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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.

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