What Determines How Banks Respond to Changes in Capital Requirements?
38 Pages Posted: 20 Apr 2016
Date Written: April 15, 2016
Legacy asset overhang and incentive to shift risk due to government guarantees can both affect bank capital issuance and lending decisions. We show that such frictions lead to ambiguous predictions on how one should expect a bank to react to a change in capital requirements. One sustained prediction is that lending is less sensitive to a change in capital requirements when lending prospects are good and legacy assets are healthy. Using UK bank regulatory data from 1989 to 2007, we find strong empirical support for this prediction.
Keywords: Debt overhang, risk-shifting, bank capital, local projections
JEL Classification: G21, G32
Suggested Citation: Suggested Citation