#08-09
How Do Large Banking Organizations Manage Their Capital Ratios?
Allen N. Berger, Robert DeYoung, Mark J. Flannery, David Lee and Ozde Oztekin
Abstract: Large banking organizations in the U.S. hold significantly more equity capital than the
minimum required by bank regulators. This capital cushion has built up during a period of unusual
profitability for the banking system, leading some observers to argue that the capital merely reflects
recent profits. Others contend that the banks deliberately choose target capital levels based on their risk
exposures and their counterparties’ sensitivities to default risk. In either case, the existence of “excess”
capital makes it difficult to observe how banks manage their capital levels, particularly in response to
regulatory changes (such as Basel II). We propose several hypotheses to explain this “excess” capital,
and test these hypotheses using annual panel data for large, publicly traded U.S. bank holding companies
(BHCs) from 1992 through 2006, and an innovative partial adjustment approach that allows both the
target capital ratios and the speed of adjustment toward those targets to vary with firm-specific
characteristics. We find evidence to suggest that large BHCs actively managed their capital ratios during
our sample period. Our tests suggest that large BHCs choose target capital levels substantially above
well-capitalized regulatory minima; that these targets increase with BHC risk but decrease with BHC size;
that BHCs adjust toward these targets relatively quickly; and that adjustment speeds are faster for poorly
capitalized BHCs, but slower (ceteris paribus) for BHCs under severe regulatory pressure.
Keywords:Banks, Capital management, Capital regulation, Partial adjustment models.
JEL classifications: .G21, G28, G32
