The cyclical behaviour of European bank capital buffers

Abstract

We examine the cyclical behaviour of European bank capital buffers using an unbalanced panel data set comprising eight years (1997)(1998)(1999)(2000)(2001)(2002)(2003)(2004) of bank balance sheet data for commercial, savings and co-operative banks. Controlling for other potential determinants of bank capital, we find that capital buffers of the banks in the accession countries (RAM10) have a significant positive relationship with the cycle, while for banks operative in the EU15 and the EA and the combined EU25 the relationship is significantly negative. We also find fairly slow speeds of adjustment, with around two-thirds of the correction towards desired capital buffers taking place each year. We further distinguish by type and size of bank, finding that capital buffers of commercial and savings banks, and also of a sub-sample of large banks, exhibit negative co-movement. Co-operative banks and smaller banks on the other hand, tend to exhibit positive cyclical co-movement.

Bank procyclicality and output: Issues and policies

“…Banks with lower quality assets exhibit higher probability of default in the downturns, which, among other things, should be considered when calculating their capital buffers (Marcucci and Quagliariello, 2009). Second, many banks maintain significantly higher regulatory capital levels than those prescribed by Basel II (Gordy andHowells, 2006 andJokipii andMilne, 2008). Third, there is heterogeneity in the risk diversification of banks' portfolios when capital adequacy rules are altered, due to characteristics of individual bank and banking sectors as well as the macroeconomic conditions in each country (Delis et al, 2012).…”

“…Further, factors such as Basel I and II, accounting rules, credit rating agencies' reports and the use of similar risk management systems have been criticized as they did not help to smooth procyclicality in the banking sector, reinforcing it instead (Kashyap and Stein, 2004;Enria et al, 2004;VanHoose, 2008;Jokipii and Milne, 2008). More precisely, these studies suggest that capital requirements may lead to procyclical behavior, reducing the supply of loans by banks.…”

Are bank loans to SMEs procyclical? Evidence from an analysis of the lending behavior of Korean banks

“…As evidence supporting procyclicality, the study found that surplus capital reduced by 17% whenever the economy increases by 1%. Jokipii and Milne (2008) analyzed banks in 15 EU countries in order to determine procyclicality of capital buffers of banks similar to bank loans. Using an unbalanced panel of accounting data from 1997 to 2004, their study showed that capital buffers of banks in the EU 15 have a significant negative co-movement with business cycles.…”

“…Domestic GDP growth is used as a proxy variable (Jokipii & Milne, 2008). The reason that bank loans to enterprises respond to macroeconomic shocks is that bank failures are more likely during recessions.…”

Bank capital, interbank contagion, and bailout policy

“…Hubbard, Kuttner, and Palia (2002) find that banks that maintain more capital charge a lower interest rate on loans. Jokipii and Milne (2008) show that capital buffers of the banks in the EU15 have a significant negative co-movement with the cycle, which exacerbates the pro-cyclical impact of Basel II . government intervention.…”