Bank capital requirements and systemic risk: Evidence from a quasi-natural experiment
34 Pages Posted: 7 Oct 2017 Last revised: 28 Dec 2018
Date Written: December 14, 2018
Using the EBA capital exercise of 2011 as a quasi-natural experiment, we investigate how capital requirements affect various measures of systemic risk. We show that systemic risk exposure increases in response to higher capital requirements. This increase is driven by a decline in the banks’ market value of equity, an increase in the systematic risk of bank returns, and an increase in the Value-at-Risk of banks. We then discuss the underlying mechanisms behind our findings. Our results are most consistent with banks actively rebalancing their portfolios which in turn results in more correlated bank assets, as well as investors stigmatizing banks that are subject to higher capital requirements. Finally, we discuss the implications of our results for policies aimed at reducing systemic risk.
Keywords: Capital requirements, systemic risk, Basel III
JEL Classification: G01, G21, G28
Suggested Citation: Suggested Citation