Has Regulatory Capital Made Banks Safer? Skin in the Game vs Moral Hazard

85 Pages Posted: 28 Feb 2019 Last revised: 3 Aug 2020

Date Written: November 9, 2019

Abstract

The paper evaluates the impact of a phased-in introduction of capital requirements on equity, risk-taking, and probability of default for a sample of European systemically important banks. Contrary to the case of a one-off introduction of capital requirements, this study does not fi nd evidence of deleveraging through asset sales. A phased-in tightening promotes adjustment to lower leverage via an increase in equity thereby improving resilience and loss absorption capacity. The higher resilience comes at the cost of a portfolio reallocation towards riskier assets. Consistently with models on agency costs and gambling for resurrection, the risk-taking is driven by large and less pro table banks. The net impact of capital requirements' tightening on bank probabilities of default is positive albeit statistically insignificant, suggesting that risk-taking may crowd-out solvency.

Keywords: capital requirements, risk-taking, moral hazard, macroprudential policy

JEL Classification: E51, G21, G28, O52

Suggested Citation

Dautović, Ernest, Has Regulatory Capital Made Banks Safer? Skin in the Game vs Moral Hazard (November 9, 2019). ECB Working Paper No. 2449, Available at SSRN: https://ssrn.com/abstract=3332501 or http://dx.doi.org/10.2139/ssrn.3332501

Ernest Dautović (Contact Author)

European Central Bank ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

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