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The benefits and costs of adjusting bank capitalisation: evidence from euro area countries

Author

Listed:
  • Budnik, Katarzyna
  • Affinito, Massimiliano
  • Barbic, Gaia
  • Ben Hadj, Saiffedine
  • Chretien, Edouard
  • Dewachter, Hans
  • Gonzalez, Clara Isabel
  • Hu, Jenny
  • Jantunen, Lauri
  • Jimborean, Ramona
  • Manninen, Otso
  • Martinho, Ricardo
  • Mencía, Javier
  • Mousarri, Elena
  • Naruševičius, Laurynas
  • Nicoletti, Giulio
  • O’Grady, Michael
  • Ozsahin, Selcuk
  • Pereira, Ana Regina
  • Rivera-Rozo, Jairo
  • Trikoupis, Constantinos
  • Venditti, Fabrizio
  • Velasco, Sofia

Abstract

The paper proposes a framework for assessing the impact of system-wide and bank-level capital buffers. The assessment rests on a factor-augmented vector autoregression (FAVAR) model that relates individual bank adjustments to macroeconomic dynamics. We estimate FAVAR models individually for eleven euro area economies and identify structural shocks, which allow us to diagnose key vulnerabilities of national banking systems and estimate short-run economic costs of increasing banks’ capitalisation. On this basis, we run a fully-fledged cost-benefit assessment of an increase in capital buffers. The benefits are related to an increase in bank resilience to adverse shocks. Higher capitalisation allows banks to withstand negative shocks and moderates the reduction of credit to the real economy that ensues in adverse circumstances. The costs relate to transitory credit and output losses that are assessed both on an aggregate and bank level. An increase in capital ratios is shown to have a sharply different impact on credit and economic activity depending on the way banks adjust, i.e. via changes in assets or equity. JEL Classification: E51, G21, G28

Suggested Citation

  • Budnik, Katarzyna & Affinito, Massimiliano & Barbic, Gaia & Ben Hadj, Saiffedine & Chretien, Edouard & Dewachter, Hans & Gonzalez, Clara Isabel & Hu, Jenny & Jantunen, Lauri & Jimborean, Ramona & Mann, 2019. "The benefits and costs of adjusting bank capitalisation: evidence from euro area countries," Working Paper Series 2261, European Central Bank.
  • Handle: RePEc:ecb:ecbwps:20192261
    Note: 1355359
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    References listed on IDEAS

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    More about this item

    Keywords

    banking system resilience; capital regulation; cost-benefit analysis; FAVAR;
    All these keywords.

    JEL classification:

    • E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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