A Primer on Regulatory Bank Capital Adjustments
60 Pages Posted: 4 Aug 2013 Last revised: 24 Mar 2014
Date Written: March 24, 2014
To calculate regulatory capital ratios, banks have to apply adjustments to book equity. These adjustments vary with a bank’s solvency position: Low solvency banks report values of Tier 1 regulatory capital that exceed book equity. These banks benefit from regulatory adjustments to inflate important regulatory solvency ratios, such as the Tier 1 leverage ratio and the Tier 1 risk-based capital ratio. In contrast, highly solvent banks report Tier 1 capital that is lower than book equity. These banks adjust their solvency ratios downward for prudential reasons, despite their resilient solvency levels. The decreasing relationship between regulatory adjustments and bank solvency reflects the cost of deleveraging, a cost that demonstrates the resistance of banks against substituting equity for debt. Therefore, the results of this paper weaken the case for regulatory adjustments.
Keywords: Banking, Regulatory Capital, Solvency, Accounting
JEL Classification: E58, G21, G28, M41
Suggested Citation: Suggested Citation