The Effects of Capital on Bank Risk-Taking: New Evidence for the European Banking System

Abstract

After the eruption of the global financial crisis, the banking sector has gone through profound regulatory reforms aimed at strengthening the stability of the entire financial system. Based on a sample of 62 listed banks in the European Economic Area Region, during the period 2005q1-2018q4, this paper investigates the impact of capital policies on bank risk-taking. Results show how the Tier 1 capital ratio and the Tier 1 leverage ratio represent a crucial factor in explaining bank risk, especially for small banks and during financial turmoil periods. Additionally, we find that the introduction of mandatory disclosure of the Tier 1 leverage ratio and the Tier 1 capital ratio reduced the bank risk-taking of higher leveraged and capitalized banks. Our findings have significant implications for both the banking industry and policymakers alike.

Do Systematically Important Banks Pursue Low-Cost Deposits: Insights from a Difference-in-Differences Estimation

“…The use of total assets as an indicator of bank size is supported in the literature. Floreani et al (2023) examined the impact of capital regulations on bank risk taking and find evidence that banks have reduced their risk exposure as a consequence of policy specifications on their capital. A larger asset size has a positive impact on revenue and profit and enables banks to use their capital more efficiently (Ngoc Nguyen, 2019).…”

Banking sector and economic growth in the digital transformation era: insights from maximum likelihood and Bayesian structural equation modeling

“…The capital base of banks not only supports their lending and investment activities but also acts as a shield against losses, thereby ensuring the stability of the overall financial system (Huu Vu and Thanh Ngo, 2023). Research by Floreani et al (2023) demonstrates that adequate bank capital is fundamental to risk management and is essential in promoting confidence among depositors and investors. Furthermore, the relationship between capital adequacy and regulatory frameworks, as discussed by Gr zeta et al (2023), recognizes the role of bank capital in supporting banks' operational practices with broader economic objectives.…”