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Bank Capital and Uncertainty

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  • Fabian Valencia

Abstract

An important role for bank capital is that of a buffer against unexpected losses. As uncertainty about these losses increases, the theory predicts an increase in the optimal level of bank capital. This paper investigates this implication empirically with U.S. Commercial Banks data and finds statistically significant and robust evidence supporting it. A counterfactual experiment suggests that a decline in uncertainty to the lowest level measured in the sample generates an average reduction in bank capital ratios of slightly over 1 percentage point. However, I also find suggestive evidence that the intensity of this precautionary motive is stronger during recessions. From a policy perspective, these results suggest that the effectiveness of countercyclical capital requirements during bad times will be undermined by banks desire to hold more capital in response to increased uncertainty.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 10/208.

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Length: 22
Date of creation: 01 Sep 2010
Date of revision:
Handle: RePEc:imf:imfwpa:10/208

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Related research

Keywords: Banking; Banks; Economic models; Financial risk; Global Financial Crisis 2008-2009; Risk management; bank capital; equation; statistics; independent variables; standard errors; banking capital; bank groups; samples; calibration; random samples; logarithm; bank regulation; bank portfolio; foreign exchange; bank capital regulation; time series; capital regulation; off balance sheet; descriptive statistics; empirical measure; banking industry; capital adequacy; empirical exercise; bank debt; bank borrowing; computation; bank credit;

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References

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  1. Shin, Hyun Song & Adrian, Tobias, 2008. "Financial intermediaries, financial stability and monetary policy," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, Federal Reserve Bank of Kansas City, pages 287-334.
  2. John Geanakoplos & Ana Fostel, 2008. "Leverage Cycles and the Anxious Economy," American Economic Review, American Economic Association, American Economic Association, vol. 98(4), pages 1211-44, September.
  3. Peura, Samu & Jokivuolle, Esa, 2004. "Simulation based stress tests of banks' regulatory capital adequacy," Journal of Banking & Finance, Elsevier, Elsevier, vol. 28(8), pages 1801-1824, August.
  4. Skander Van den Heuvel, 2006. "The Bank Capital Channel of Monetary Policy," 2006 Meeting Papers, Society for Economic Dynamics 512, Society for Economic Dynamics.
  5. Fabian Valencia, 2008. "Banks' Precautionary Capital and Credit Crunches," IMF Working Papers 08/248, International Monetary Fund.
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Cited by:
  1. von Furstenberg, George M., 2011. "Contingent capital to strengthen the private safety net for financial institutions: Cocos to the rescue?," Discussion Paper Series 2: Banking and Financial Studies 2011,01, Deutsche Bundesbank, Research Centre.
  2. Coffinet, Jérôme & Coudert, Virginie & Pop, Adrian & Pouvelle, Cyril, 2012. "Two-way interplays between capital buffers and credit growth: Evidence from French banks," Journal of International Financial Markets, Institutions and Money, Elsevier, Elsevier, vol. 22(5), pages 1110-1125.

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