ESRB Paper Examines Whether Regulatory Capital Has Made Banks Safer

The paper finds that the EU-wide regulatory effort to increase the resilience of the banking sector has contributed to a better capitalized European financial system. A one percentage-point hike in capital requirements leads to an average common equity tier 1 (CET1) capital increase of 13% and no evidence of reduction in assets. However, the increase in capital comes at a cost. The paper documents robust evidence on the existence of substitution effects toward riskier assets. The risk-taking behavior is predominantly driven by large and less profitable banks: large wholesale funded banks show less risk taking and large banks relying on internal ratings based approach successfully disguise their risk taking. In terms of the overall impact on solvency, the higher risk taking crowds-out the positive effect of increased capital.

Related Link: Working Paper (PDF)

Keywords: Europe, EU, Banking, Regulatory Capital, IRB Approach, Macro-Prudential Policy, Systemic Risk, G-SIB, ESRB