Max Headroom: Discretionary Capital Buffers and Bank Risk
49 Pages Posted: 18 Jun 2020 Last revised: 17 Oct 2022
Date Written: May 26, 2020
This paper examines the association between discretionary capital buffers, capital requirements, and risk for the 99 largest European banks from 2013 to 2020. Discretionary buffers are banks’ own buffers, or headroom: the difference between reported and required capital. Against the backdrop of steadily increasing capital requirements over the sample period, I exploit unique and detailed Pillar 2 data that banks disclose since the release of a 2015 European Banking Authority opinion. I show that less headroom is associated with increased bank risk, even for well-capitalized banks. An additional examination of banks’ responses to the 2016 and 2018 EBA stress tests reveals that banks supervised by the ECB struggled to improve headroom. Overall, I document limitations of the effectiveness of bank capital requirements.
Keywords: Banking, European Banks, Pillar 2 requirements, SREP
JEL Classification: E58, G21, G32, M41
Suggested Citation: Suggested Citation