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
Date Written: August 2004
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: Suggested Citation