Do Tougher Bank Capital Requirements Matter? New Evidence from the Eighties

Abstract:     
In contrast to existing research, I find that tougher capital requirements were probably not responsible for the increase in capital ratios throughout the 1980s. Banks with low capital ratios tended to mean-revert well before any change in policy, and did not raise their capital ratios any faster after the policy change relative to better-capitalized banks. These conclusions are unchanged when exploiting a natural experiment - the plausibly exogenous elimination of differences across Federal Reserve System membership status in leverage requirements for community banks in 1985. I argue that these results are consistent with the presence of market-based incentives for banks to hold capital so that existing regulatory capital requirements were not binding.

Number of Pages in PDF File: 39

Keywords: Bank capital requirements, moral hazard, bank regulation

JEL Classification: E53, G21, G18

working papers series