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Bank reactions after capital shortfalls

Listed author(s):
  • Kok, Christoffer
  • Schepens, Glenn

This paper investigates whether European banks have capital targets and how deviations from the target impact their equity composition and activity mix. Using quarterly data for a sample of large European banks between 2004 and 2011, we show that there are notable asymmetries in banks' reactions to deviations from optimal capital levels. Banks prefer to reshuffle risk-weighted assets or increase asset holdings when being above their optimal Tier 1 ratio, whereas they rather try to increase equity levels or reshuffle risk-weighted assets without changing asset holdings when being below target. At the same time, focusing instead on a unweighted equity ratio target, we find evidence of deleveraging and lower loan growth for undercapitalized banks during the recent financial crisis, whereas in the pre-crisis periods banks primarily reacted to deviations from their optimal target by adjusting equity levels. JEL Classification: D22, E44, G20, G21, G28

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Paper provided by European Central Bank in its series Working Paper Series with number 1611.

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Date of creation: Nov 2013
Handle: RePEc:ecb:ecbwps:20131611
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