We thank an anonymous referee, John Doukas (the editor), Giuliano Iannotta, Andrea Sironi, Phil Molyneux, Jon Williams, Bob DeYoung, Enrica Detragiache, Karyen Chu, Katja Neugebauer, Gary Fissel, Paul Kupiec, Steven Seelig, Alexander Tieman, Marcel Tyrell, Joerg Decressin, Daniel Hardy, Jochen Schanz, Enrico Onali, Carlos Alegria, Simon Wolfe, and Masaki Yamada. We also thank seminar and conference participants at the International Monetary Fund, the Federal Deposit Insurance Corporation, the Bank of England, the University of Southampton, Bocconi University, the European Conference on Financial Regulation and Supervision (‘FinLawMetrics’) in Milan, the Tor Vergata Conference in Rome, the Midwest Finance Conference in San Antonio, and the Paris International Finance Meeting. All remaining errors are our own. This paper's findings, interpretations, and conclusions are those of the authors and do not necessarily reflect the views of the International Monetary Fund. Correspondence: Klaus Schaeck.
Banking Competition and Capital Ratios
Article first published online: 15 JUN 2010
© 2010 Blackwell Publishing Ltd
European Financial Management
Volume 18, Issue 5, pages 836–866, November 2012
How to Cite
Schaeck, K. and Cihák, M. (2012), Banking Competition and Capital Ratios. European Financial Management, 18: 836–866. doi: 10.1111/j.1468-036X.2010.00551.x
- Issue published online: 17 OCT 2012
- Article first published online: 15 JUN 2010
- bank capital;
- deposit insurance;
- shareholder rights
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.