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Regulation of Bank Capital and Behavior of Banks: Assessing the US and the EU-15 Region Banks in the 2000-2005 Period

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Abstract

In recent years, regulators have increased their focus on the capital adequacy of banking institutions to enhance their stability, hence the stability of the whole financial system. The purpose of this paper is to assess and compare how American and European banks adjust their level of capital and portfolio risk under capital regulation, whether and how they react to constraints placed by the regulators. In order to do this, we estimate a modified version of the simultaneous equations model developed by Shrieves and Dahl. This model analyzes adjustments in capital and risk at banks when they approach the minimum regulatory capital level. The results indicate that regulatory requirements have the desired effect on bank behavior. Both American and European banks that are close to minimum requirements simultaneously increase their capital. In addition, the US banks decrease their portfolio risk taking.

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File URL: http://ies.fsv.cuni.cz/default/file/download/id/6419
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Paper provided by Charles University Prague, Faculty of Social Sciences, Institute of Economic Studies in its series Working Papers IES with number 2007/23.

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Length: 22 pages
Date of creation: Aug 2007
Date of revision: Aug 2007
Handle: RePEc:fau:wpaper:wp2007_23

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Keywords: banking regulation; Basel Capital Accord; capital adequacy; banks; simultaneous equations model;

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  1. Kraeussl, Roman, 2003. "A Critique on the Proposed Use of External Sovereign Credit Ratings in Basel II," CFS Working Paper Series 2003/23, Center for Financial Studies (CFS).
  2. Abhiman Das & Saibal Ghosh, 2004. "The Relationship Between Risk and Capital: Evidence from Indian Public Sector Banks," Industrial Organization 0410006, EconWPA.
  3. Andrew Powell, 2004. "Basel II and Developing Countries: Sailing through the Sea of Standards," Business School Working Papers baseldc, Universidad Torcuato Di Tella.
  4. Edward Simpson Prescott, 2004. "Auditing and bank capital regulation," Economic Quarterly, Federal Reserve Bank of Richmond, issue Fall, pages 47-63.
  5. Jacques, Kevin & Nigro, Peter, 1997. "Risk-based capital, portfolio risk, and bank capital: A simultaneous equations approach," Journal of Economics and Business, Elsevier, vol. 49(6), pages 533-547.
  6. Aggarwal, Raj & Jacques, Kevin T., 2001. "The impact of FDICIA and prompt corrective action on bank capital and risk: Estimates using a simultaneous equations model," Journal of Banking & Finance, Elsevier, vol. 25(6), pages 1139-1160, June.
  7. Shrieves, Ronald E. & Dahl, Drew, 1992. "The relationship between risk and capital in commercial banks," Journal of Banking & Finance, Elsevier, vol. 16(2), pages 439-457, April.
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