The Relationship between Risk and Capital in Commercial Banks

Abstract

This study investigates the relationship between changes in risk and capital in a large sample of banks. A positive association between changes in risk and capital is found. The fact that this finding holds in banks with capital ratios in excess of regulatory minimum levels supports the conclusion that, for most banks, bank owners' and/or managers' private incentives work to limit total risk exposure. Results for banks which were undercapitalized by regulatory standards indicate that regulation was at least partially effective during the period covered. Overall, the findings support a conclusion that changes in bank capital over the period studied have been ‘risk-based’.