Capital requirements: A pillar or a burden for bank competitiveness?

This paper examines the relationship between capital requirements, capital ratios and bank competitiveness - measured as profit efficiency. Using data envelopment analysis techniques, profit efficiency scores were estimated for a sample of listed significant institutions directly supervised by the European Central Bank. In calculating the scores, use was made of rich supervisory data on bank-specific characteristics and capital requirements, in addition to macroeconomic variables. The findings revealed that capital requirements do not have a statistically significant effect on profit efficiency. The insignificant relationship also held true when capital requirements were broken down into microprudential and macroprudential requirements. For capital ratios, the relationship with profit efficiency was linearly statistically insignificant, but did display a statistically significant non-linear relationship that followed an inverted U-shape: profit efficiency rose with capital up to a threshold (estimated at a common equity tier 1 ratio of around 18%), after which further increases curbed profit efficiency. These findings were robust to a wide battery of robustness checks, including an extension of the sample to unlisted banks and the use of different efficiency measures and of various methods to control for confounding factors. These results underscore the need for policymakers to ensure that banks remain resilient, maintain strong capital ratios and manage risk well. In addition, they point to the intricate link between bank capital, regulation and competitiveness, contributing to the ongoing debate about the European banking sector's ability to support economic growth and innovation.