Regulation of Bank Capital and Behavior of Banks: Assessing the US and the EU-15 Region Banks in the 2000-2005 Period

In recent years, regulators have increased their focus on the capital adequacy of banking institutions to enhance their stability, hence the stability of the whole financial system. The purpose of this paper is to assess and compare how American and European banks adjust their level of capital and portfolio risk under capital regulation, whether and how they react to constraints placed by the regulators. In order to do this, we estimate a modified version of the simultaneous equations model developed by Shrieves and Dahl. This model analyzes adjustments in capital and risk at banks when they approach the minimum regulatory capital level. The results indicate that regulatory requirements have the desired effect on bank behavior. Both American and European banks that are close to minimum requirements simultaneously increase their capital. In addition, the US banks decrease their portfolio risk taking.