Bank Capital and Uncertainty

23 Pages Posted: 11 Sep 2010

See all articles by Fabián Valencia

Fabián Valencia

International Monetary Fund (IMF)

Multiple version iconThere are 2 versions of this paper

Date Written: September 1, 2010

Abstract

An important role for bank capital is that of a buffer against unexpected losses. As uncertainty about these losses increases, the theory predicts an increase in the optimal level of bank capital. This paper investigates this implication empirically with U.S. Commercial Banks data and finds statistically significant and robust evidence supporting it. A counterfactual experiment suggests that a decline in uncertainty to the lowest level measured in the sample generates an average reduction in bank capital ratios of slightly over 1 percentage point. However, I also find suggestive evidence that the intensity of this precautionary motive is stronger during recessions. From a policy perspective, these results suggest that the effectiveness of countercyclical capital requirements during bad times will be undermined by banks' desire to hold more capital in response to increased uncertainty.

Keywords: Banking, Banking Capital, Risk, Uncertainty

JEL Classification: C61, E32, E44

Suggested Citation

Valencia, Fabian V., Bank Capital and Uncertainty (September 1, 2010). IMF Working Paper No. 10/28. Available at SSRN: https://ssrn.com/abstract=1675004 or http://dx.doi.org/10.2139/ssrn.1675004

Fabian V. Valencia (Contact Author)

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

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