The Effects of Capital on Bank Risk-Taking: New Evidence for the European Banking System

After the eruption of the global financial crisis, the banking sector has gone through profound regulatory reforms aimed at strengthening the stability of the entire financial system. Based on a sample of 62 listed banks in the European Economic Area Region, during the period 2005q1-2018q4, this paper investigates the impact of capital policies on bank risk-taking. Results show how the Tier 1 capital ratio and the Tier 1 leverage ratio represent a crucial factor in explaining bank risk, especially for small banks and during financial turmoil periods. Additionally, we find that the introduction of mandatory disclosure of the Tier 1 leverage ratio and the Tier 1 capital ratio reduced the bank risk-taking of higher leveraged and capitalized banks. Our findings have significant implications for both the banking industry and policymakers alike.