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Capital requirements and risk-taking in community banks: The role of market power

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Listed:
  • Yang, Chenzi
  • Yang, Guang-Zhao
  • Moreira, Fernando
  • Archibald, Thomas Welsh

Abstract

This paper examines the impact of capital requirements on risk-taking in U.S. community banks. While existing literature highlights capital requirements’ influence on liquidity and credit risks, the differential impact across market power characteristics especially for smaller institutions remains unclear. Using data from 5702 U.S. community banks, we employ 2SLS-IV models to reveal an inverted U-shaped effect of capital requirements on liquidity risk and a U-shaped effect on credit risk. The impact of capital requirements diminishes as market power increases, particularly in banks with lower liquid assets, liabilities, and transaction deposits. The impact of Tier 1 and CET1 capital requirements exhibit similar patterns, while CCB requirements display an opposite trend. These findings offer new insights into financial risk management, highlighting the need for tailored regulatory approaches for community banks with low market power to enhance overall stability.

Suggested Citation

  • Yang, Chenzi & Yang, Guang-Zhao & Moreira, Fernando & Archibald, Thomas Welsh, 2026. "Capital requirements and risk-taking in community banks: The role of market power," Economic Modelling, Elsevier, vol. 156(C).
    • Handle: RePEc:eee:ecmode:v:156:y:2026:i:c:s0264999325004663
    DOI: 10.1016/j.econmod.2025.107471
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    JEL classification:

    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G38 - Financial Economics - - Corporate Finance and Governance - - - Government Policy and Regulation

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