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The effect of stricter capital regulation on banks’ risk‐taking: Theory and evidence

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  • Frederik Lundtofte
  • Caren Yinxia Nielsen

Abstract

A simple portfolio choice model shows that, when a bank's capital is constrained by regulation, regulatory cost (risk weightings) alters the risk and value calculations for the bank's assets. In particular, we find that banks may respond to stricter regulation by increasing the share of high‐risk assets. Our empirical results show that US banks responded to the implementation of the stricter Basel II regulations by increasing the share of high‐risk assets in the risky part of their portfolios.

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  • Frederik Lundtofte & Caren Yinxia Nielsen, 2019. "The effect of stricter capital regulation on banks’ risk‐taking: Theory and evidence," European Financial Management, European Financial Management Association, vol. 25(5), pages 1229-1248, November.
    • Handle: RePEc:bla:eufman:v:25:y:2019:i:5:p:1229-1248
    DOI: 10.1111/eufm.12205
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    Cited by:

    1. Poshakwale, Sunil & Aghanya, Daniel & Agarwal, Vineet, 2020. "The impact of regulations on compliance costs, risk-taking, and reporting quality of the EU banks," International Review of Financial Analysis, Elsevier, vol. 68(C).

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