How Do Banks React to Increased Asset Risks? Evidence from Hurricane Katrina
Goethe University Frankfurt - Chair of Econometrics
Otto-von-Guericke University; Halle Institute for Economic Research
Goethe University Frankfurt - Department of Finance
March 1, 2012
29th International Conference of the French Finance Association (AFFI) 2012
The instability of banks during the recent financial crisis underlines the importance of understanding how banks determine their capital ratios. This paper conducts the first empirical assessment on how banks adjust their capital ratios following an exogenous shock to their asset risks. The existing literature, which uses non-experimental identfication, faces the diffculty that banks typically determine capital ratios and asset risks simultaneously. Using Hurricane Katrina as a natural experiment, we find that banks in the disaster areas increase their risk-based capital ratios after the hurricane. This finding shows that banks act precautious by themselves irrespective of regulatory requirements. However, when we examine low-capitalized and high-capitalized banks separately, we find that results are driven by high-capitalized banks. In addition, high-capitalized banks increase their risk-based capital ratios by decreasing loans and not by increasing capital.
Number of Pages in PDF File: 43
Keywords: financial crisis, bank regulation, capital requirements, natural experiment
JEL Classification: G21, G28
Date posted: October 9, 2012
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