Banking competition and capital ratios

Research output: Contribution to journalArticle

Electronic versions

  • K. Schaeck
  • M. Cihak
Empirical studies provide evidence that bank capital ratios exceed regulatory requirements. But why do banks maintain capital levels above regulatory requirements? We use data for more than 2,600 banks from 10 European countries to test recent theories suggesting that competition incentivises banks to maintain higher capital ratios. These theories also predict that banks that engage in arm's length lending have lower capital ratios, and that shareholder rights and deposit insurance characteristics affect capital ratios. Consistent with these theories, our evidence robustly indicates that competition increases capital holdings. Banks that lend at arm's length exhibit lower capital ratios, whereas banks in countries with strong shareholder rights operate with higher capital ratios. We also show some evidence that generous deposit protection schemes that exclude non-deposit creditors are associated with higher capital ratios. Our results have important policy implications. First, while the traditional view suggests imposing restrictions on bank activities in order to restrain competition, our analysis indicates the opposite, even after adjusting the regressions for risk-taking. Second, weak shareholder rights undermine market forces that would otherwise encourage banks to hold higher capital ratios.
Original languageEnglish
Pages (from-to)836-866
JournalEuropean Financial Management
Volume18
Issue number5
Early online date15 Jun 2010
DOIs
Publication statusPublished - Nov 2012
View graph of relations