Bank Capital and Uncertainty

Author/Editor: Valencia, Fabian
Publication Date: September 01, 2010
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Disclaimer: This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate
Summary: An important role for bank capital is that of a buffer against unexpected losses. As uncertainty about these losses increases, the theory predicts an increase in the optimal level of bank capital. This paper investigates this implication empirically with U.S. Commercial Banks data and finds statistically significant and robust evidence supporting it. A counterfactual experiment suggests that a decline in uncertainty to the lowest level measured in the sample generates an average reduction in bank capital ratios of slightly over 1 percentage point. However, I also find suggestive evidence that the intensity of this precautionary motive is stronger during recessions. From a policy perspective, these results suggest that the effectiveness of countercyclical capital requirements during bad times will be undermined by banks desire to hold more capital in response to increased uncertainty.
Series: Working Paper No. 10/208
Subject(s): Banking | Banks | Business cycles | Capital | Debt | Economic models | Financial crisis | Financial risk | Global Financial Crisis 2008-2009 | Risk management | United States

Author's Keyword(s): Banking | Banking Capital | Risk | Uncertainty
Publication Date: September 01, 2010
Format: Paper
Stock No: WPIEA2010208 Pages: 22
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