Optimal level of capital in the Polish banking sector

This study presents estimates of the optimal level of aggregate Tier 1 capital ratio in the Polish banking sector. The analysis takes into account macroeconomic benefits of raising Tier 1 capital ratio and macroeconomic costs related to it. The main macroeconomic benefit from a higher capital captured in the study is a higher resilience of the banking sector and consequently a reduction in the likelihood of a banking crisis. The benefit of higher capital ratios is expressed as the product of a decrease in the likelihood of a crisis and the expected cost of a crisis. The latter was calibrated based on the literature review. The probabilities of crisis for different levels of capital were calculated based on probit models estimated on macro data and a simulation model reflecting some of the main features of the banking sector in Poland. The SVAR model estimated on data for the Polish economy was used to assess the scale of the slowdown in GDP growth due to a rise of capital ratios. The net effect of an increase of capital ratios, expressed as a percentage of GDP, reflects the difference between their expected benefits due to the reduction in the probability of a crisis and their economic costs in the form of a decrease in the expected GDP growth rate. The level of Tier 1 ratio, at which the net effect, i.e. the difference between benefits and costs of raising capital ratios, is the largest, is called optimal from a macroeconomic perspective. The results indicate that the optimal level of aggregate Tier 1 ratio is in the range of 11%-23% with the expected value derived from this analysis and the literature at the level of 18%.