How Do Markets React to Tighter Bank Capital Requirements?

37 Pages Posted: 7 Jul 2020 Last revised: 18 Nov 2021

See all articles by Cyril Couaillier

Cyril Couaillier

Banque de France; European Central Bank (ECB)

Dorian Henricot

Banque de France

Date Written: September 1, 2021

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

Suggested Citation

Couaillier, Cyril and Henricot, Dorian, How Do Markets React to Tighter Bank Capital Requirements? (September 1, 2021). Banque de France Working Paper No. 772, Available at SSRN: https://ssrn.com/abstract=3641364 or http://dx.doi.org/10.2139/ssrn.3641364

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Dorian Henricot

Banque de France ( email )

Paris
France

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