What Caused the Bank Capital Build-Up of the 1990s?

FDIC Center For Financial Research Working Paper No. 2004-03

50 Pages Posted: 1 Apr 2005

See all articles by Mark J. Flannery

Mark J. Flannery

University of Florida - Department of Finance, Insurance and Real Estate

Kasturi P. Rangan

Case Western Reserve University - Department of Banking & Finance

Multiple version iconThere are 2 versions of this paper

Date Written: August 2004

Abstract

Large U.S. banks dramatically increased their capitalization during the 1990s, to the highest levels in more than 50 years. We document this buildup of capital and evaluate several potential motivations. Our results support the hypothesis that regulatory innovations in the early 1990s weakened conjectural government guarantees and enhanced the bank counterparties' incentive to monitor and price default risk. We find no evidence that a bank holding company's market capitalization increases with its asset volatility prior to 1994. Thereafter, the data display a strong cross-sectional relation between capitalization and asset risk. Our estimates indicate that most of the bank capital buildup over the sample period can be explained by greater bank risk exposures and the market's increased demand that large banks' default risk be priced.

Keywords: Bank capital, bank risk, market discipline

JEL Classification: G18, G14

Suggested Citation

Flannery, Mark Jeffrey and Rangan, Kasturi P., What Caused the Bank Capital Build-Up of the 1990s? (August 2004). FDIC Center For Financial Research Working Paper No. 2004-03. Available at SSRN: https://ssrn.com/abstract=681245 or http://dx.doi.org/10.2139/ssrn.681245

Mark Jeffrey Flannery (Contact Author)

University of Florida - Department of Finance, Insurance and Real Estate ( email )

P.O. Box 117168
Gainesville, FL 32611
United States
352-392-3184 (Phone)
352-392-0103 (Fax)

Kasturi P. Rangan

Case Western Reserve University - Department of Banking & Finance ( email )

10900 Euclid Ave.
Cleveland, OH 44106-7235
United States
216-368-3688 (Phone)
216-368-4776 (Fax)

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