Bank Risk-Taking and Deposit Price in Times of Low Economic Activity: Relevance or Irrelevance of Capital Requirements?

This paper investigates the influence of bank capital regulation on their portfolio risk and deposit financing costs, assuming that the regulatory burden of capital requirements might trigger adverse effects on bank asset riskiness, regardless of the potentially positive impact on lowering deposit price. Data for the Croatian banking sector in the 2011-2019 time span served as an input for the dynamic panel analysis. The results confirm that banks with higher capital ratios do not have lower deposit financing costs, but tend to make risky investments to compensate their shareholders for the demand for additional funds. In addition, bank size, previous credit risk materialization, and higher economic growth reduce asset riskiness exposure, while bank profitability (net interest margin) is consistent with risk-taking behaviour. Deposit price is positively influenced by the interbank market conditions, while return on equity and portfolio risk have a negative impact. All in all, there is solid evidence that the capital requirements regulation significantly alters bank business indicators, more precisely bank asset riskiness. However, remarks about its counterproductive effects on banking stability require more convincing and comprehensive evidence against the capital buffer theory. The unavailability of data has prevented us from disaggregating bank riskiness by type and using composite measures such as the risk index. Nevertheless, this research is one of the few for the Croatian banking sector in the area of microeconomic consequences of the adjustment to capital requirements.