Economics of Capital Adjustment in the US Commercial Banks: Empirical Analysis

Abstract

Using GMM framework on the data of the US commercial banks over the period from 2002 to 2018, this study shows that banks adjust their regulatory capital ratios faster than traditional capital ratios; and, in most cases, the speed of adjustment of a traditional capital ratio is lower than regulatory capital ratios. Our results show that the speed of regulatory capital ratio of well-capitalized banks is faster than adequately-capitalized and under-capitalized banks. Our analysis report that high-liquid banks adjust their capital ratios faster than low-liquid banks. We also find that the speed of adjustment of regulatory capital of too-big-to-fail banks is lower than well-capitalized, adequately-capitalized, nationally-chartered, and state-chartered banks. In addition, the speed of adjustment of regulatory capital ratios of commercial banks is higher in the post-crisis period than the pre-crisis era. Although scholars suggest that adjustment of capital ratios through rebalancing liabilities is more beneficial to the banks, our findings show that banks also use their assets side of balance sheet to rebalance their capital ratios. Our findings suggest that the regulators may consider the heterogeneity in the speed of capital adjustment across different bank characteristics for the formulation of new bank regulations; particularly, when assessing and adjusting the specific capital requirements through Pillar II of the Basel III agreement.

Keywords: Capital Ratio, Regulatory Ratio, Tier-I Ratio, Speed of Capital Adjustment, Bank Charters

JEL Classification: G20, G21, G28