Optimal capital, regulatory requirements and bank performance in times of crisis: Evidence from France

The recent implementation of the Basel III framework has re-ignited the debate around the link between capital, performance and capital requirements in the banking sector. There is a dominant view in the earlier empirical literature in favor of a positive effect of capital on banking performance. Using panel data gathered for the supervision of French banks, we also find evidence of the beneficial effect of higher capital, but try to go one step further by distinguishing between regulatory and voluntary capital. Using a two-step estimation procedure, taking advantage of the variability of data since the crisis, and controlling for many factors (risk, asset composition, etc), we show that voluntary capital, i.e. capital held by banks irrespective of their regulatory requirements, turns out to be the sole component of capital that positively affects performance, as measured by the return on asset (ROA). In contrast, the effect of regulatory capital on the ROA appears insignificant, indicating that over the 2007-2014 period increasing capital requirements have not been detrimental to banking performance in France.