The Effectiveness of Regulatory Capital Requirements Prior to the Onset of the Financial Crisis

We extend the literature on the role of capital requirements as a regulatory tool by developing a continuous measure of the degree of regulatory pressure and by examining data on US commercial banks during the economic upturn that preceded the 2007–2009 financial crisis. Our findings indicate the inability of regulatory pressure to force banks to build capital buffers during the economic upturn that preceded the crisis. These findings are consistent with the view that banks entered the crisis with inadequate levels of capital. Our findings support the endeavors of regulators in explicitly demanding capital buffers in their new regulatory framework.