De-Risking Through Equity Holdings: Bank and Insurer Behavior Under Capital Requirements
Posted: 9 Jun 2020
Date Written: April 30, 2020
Using a sample from 1980 to 2018, we find that banks and insurers in U.S. diversify financial risk through their equity holdings. They tend to offset the risk of increased leverage by lowering the leverage of the non-financial firms in which they take an equity stake. We attribute this finding to the impact of risk-based capital regulations. Facing the high cost of equity, financial institutions are well incentivized to comply with increased capital requirements by reducing asset risk. Our results demonstrate that the scope of the induced de-risking activities of these institutions is not limited to their credit portfolios but extends to their equity exposure as well. We also show that non-financial firms that are concerned about being dropped by these financial institutions could deleverage to deviate from their theoretically optimal capital structures. These novel empirical regularities need to be included in debates about capital regulations for banks and insurance companies.
Keywords: Risk-based capital requirements; Capital structure; De-risking; Security issues
JEL Classification: G32; G21; G28
Suggested Citation: Suggested Citation