The Role of Regulatory Pressure in Banks’ Capital and Risk Decisions

Abstract

Capital regulation represents the core of prudential regulation in banking. Despite the aim of the regulators to have a safer and more robust banking industry, the effects of capital regulation on banks’ capital and risk decisions appear ambiguous. The paper analyses the relationship between capital and risk changes and the impact of regulatory pressure for a sample of European banks during the period 2006–2010, which encompasses the start of the latest financial crisis. Results highlight that banks tend to adopt a different behaviour depending on the capital ratio considered, supporting the so-called ‘gamble for resurrection’ hypothesis. Evidence supports the rethinking of the regulatory framework, especially with reference to higher and stricter capital requirements