Capital Requirements and Bank Behaviour in the Early 1990: Cross-Country Evidence

This paper uses a simultaneous-equations model to investigate how banks from six G-10 countries adjusted their capital and their risk-weighted assets after the passage of the 1988 Basel Accord. In particular, the analysis tests whether weakly capitalized banks increased their capital or decreased their risk-weighted assets more rapidly than did well-capitalized banks. If so, did market discipline play a significant role? The results suggest that only in the United States were weakly capitalized banks observed to increase their capital ratios faster than well-capitalized banks; however, the weakly capitalized U.S. banks did not modify their risk-weighted assets at different rates from other U.S. banks. In addition, market discipline appears to have played an essential role: weakly capitalized U.S. banks that did not also face market pressure did not increase their capital ratios faster than other U.S. banks. This suggests that market pressure was an important factor in the capital build-up of the early 1990s.