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Regulation of Bank Capital and Behavior of Banks: Assessing the US and the EU-15 Region Banks in the 2000-2005 Period

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Abstract

In recent years, regulators have increased their focus on the capital adequacy of banking institutions to enhance their stability, hence the stability of the whole financial system. The purpose of this paper is to assess and compare how American and European banks adjust their level of capital and portfolio risk under capital regulation, whether and how they react to constraints placed by the regulators. In order to do this, we estimate a modified version of the simultaneous equations model developed by Shrieves and Dahl. This model analyzes adjustments in capital and risk at banks when they approach the minimum regulatory capital level. The results indicate that regulatory requirements have the desired effect on bank behavior. Both American and European banks that are close to minimum requirements simultaneously increase their capital. In addition, the US banks decrease their portfolio risk taking.

Suggested Citation

  • Petr Teply & Milan Matejašák, 2007. "Regulation of Bank Capital and Behavior of Banks: Assessing the US and the EU-15 Region Banks in the 2000-2005 Period," Working Papers IES 2007/23, Charles University Prague, Faculty of Social Sciences, Institute of Economic Studies, revised Aug 2007.
  • Handle: RePEc:fau:wpaper:wp2007_23
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    References listed on IDEAS

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    1. Abhiman Das & Saibal Ghosh, 2004. "The Relationship Between Risk and Capital: Evidence from Indian Public Sector Banks," Industrial Organization 0410006, EconWPA.
    2. Roman Kraeussl, "undated". "A Critique on the Proposed Use of External Sovereign Credit Ratings in Basel II," Working Papers 0315, University of Crete, Department of Economics.
    3. Edward Simpson Prescott, 2004. "Auditing and bank capital regulation," Economic Quarterly, Federal Reserve Bank of Richmond, issue Fall, pages 47-63.
    4. Shrieves, Ronald E. & Dahl, Drew, 1992. "The relationship between risk and capital in commercial banks," Journal of Banking & Finance, Elsevier, vol. 16(2), pages 439-457, April.
    5. Aggarwal, Raj & Jacques, Kevin T., 2001. "The impact of FDICIA and prompt corrective action on bank capital and risk: Estimates using a simultaneous equations model," Journal of Banking & Finance, Elsevier, vol. 25(6), pages 1139-1160, June.
    6. Barth, James R. & Caprio, Gerard Jr. & Levine, Ross, 2004. "Bank regulation and supervision: what works best?," Journal of Financial Intermediation, Elsevier, vol. 13(2), pages 205-248, April.
    7. Powell, Andrew, 2004. "Basel II and developing countries : Sailing through the sea of standards," Policy Research Working Paper Series 3387, The World Bank.
    8. Jacques, Kevin & Nigro, Peter, 1997. "Risk-based capital, portfolio risk, and bank capital: A simultaneous equations approach," Journal of Economics and Business, Elsevier, vol. 49(6), pages 533-547.
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    More about this item

    Keywords

    banking regulation; Basel Capital Accord; capital adequacy; banks; simultaneous equations model;

    JEL classification:

    • C30 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - General
    • 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

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