Regulatory capital management and available-for-sale securities: Evidence from the Covid-19 pandemic

Using the Covid-19 pandemic as an exogenous shock to banks’ regulatory capital in a difference-in-differences framework, we find evidence consistent with a crisis-induced regulatory capital management through realized gains on available-for-sale securities. In the cross-section, the results are more pronounced, as expected, for non-advanced approaches banks who filter unrealized available-for-sale securities gains or losses from CET 1 capital. Validation tests reveal an increase (decrease) in banks’ CET 1 capital ratio (available-for-sale and held-to-maturity securities holdings) amid the pandemic. By implication, banks tend to exploit the discretion offered by accounting standards and prudential requirements to manage regulatory capital ratios in times of stress.