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

Abstract

The paper evaluates the impact of macroprudential capital regulation on bank capital, risk taking behaviour, and solvency. The identification relies on an exogenous policy change in bank-level capital requirements across systemically important banks in Europe. A one percentage point hike in capital requirements leads to an average CET1 capital level increase of 13 percent improving their loss absorption capacity. The paper does not find evidence of costs due to reduction in assets. The paper documents robust evidence on the existence of substitution effects toward riskier assets. Consistently with arguments on agency costs and gambling for resurrection, the risk taking behavior is predominantly driven by large and less profitable banks. Large wholesale funded banks show less risk taking. In terms of overall impact on solvency, the higher risk taking crowds-out the positive effect of increased capital.

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

JEL Classification: E51, G21, O52