A Positive Analysis of Bank Behavior Under Capital Requirements

59 Pages Posted: 1 Oct 2017

See all articles by Saleem Bahaj

Saleem Bahaj

UCL Economics

Frederic Malherbe

University College London - Department of Economics

Date Written: March 1, 2017

Abstract

We propose a theory of bank behaviour under capital requirements that accounts for both risk-shifting incentives and debt overhang considerations. A key result is that the bank’s lending response to an increase in the requirement need not be negative. The sign and the magnitude of the response depend on the bank’s balance sheet and economic prospects, and lending is typically U-shaped in the requirement. Using UK regulatory data, we find empirical support for the hypothesis that a bank mainly adjusts to a higher requirement by cutting lending when expected returns are low, but by raising capital when they are high.

JEL Classification: G21, G28

Suggested Citation

Bahaj, Saleem and Malherbe, Frederic, A Positive Analysis of Bank Behavior Under Capital Requirements (March 1, 2017). Available at SSRN: https://ssrn.com/abstract=3045065 or http://dx.doi.org/10.2139/ssrn.3045065

Saleem Bahaj (Contact Author)

UCL Economics ( email )

30 Gordon Street
London, England WC1H 0AX
United Kingdom

Frederic Malherbe

University College London - Department of Economics ( email )

Drayton House, 30 Gordon Street
30 Gordon Street
London, WC1H 0AX
United Kingdom

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