Adjusting denominators of capital ratios: Evidence from Japanese banks

This study examines Japanese banks’ behavior of adjusting denominators of capital ratios upon the introduction of Basel II regulations. The first analysis investigates the adjustments to the size and composition of portfolios to achieve the target risk-weighted asset (RWA). The second analysis investigates how quickly banks adjust the numerator and denominator of their capital ratio. We find evidence that banks adjusted the composition of their assets faster than their asset size to achieve the RWA targets under the macroeconomic and institutional conditions in Japan. In addition, we find that banks adjusted their level of regulatory capital faster than their RWAs to achieve the capital ratio targets. Furthermore, we find that banks that had less capital surplus shifted their portfolio composition toward lower-risk assets without reducing the total assets. The analyses provide policy implications for the time-varying minimum standards of Basel III.