How Do Markets React to Tighter Bank Capital Requirements?

Abstract

We use hikes in the countercyclical capital buffer [CCyB] to measure how markets react to tighter bank capital requirements. Our identification strategy relies on two unique features of the CCyB institutional framework in Europe. First, all national authorities make quarterly announcements of CCyB rates. Second, these hikes affect all European banks proportionally to their exposure to the country of activation. We show that CCyB hikes translate in lower CDS spreads for affected banks, in particular those with lower capital ratios. On the other hand, bank valuations do not react. Markets therefore consider that higher countercyclical capital requirements make banks more stable at no material cost for shareholders. We claim that these effects relate to the capital constraint itself, as opposed to the potential signal conveyed on the state of the financial cycle.

Keywords: Event Studies, Banking, Capital Requirements

JEL Classification: G14, G21, G28