Bank Equity Risk

Financial regulation has led banks to increase their equity ratios. Yet, several studies find that this has not led to a decrease in bank equity risk. We show theoretically, that keeping less capital in excess of the minimum capital requirement can outweigh the risk-reducing effect on equity of increased total capitalization. Empirically, we find that excess capitalization is a significant determinant of equity risk, and can explain why bank equity risk has not become lower after the Great Financial Crisis. Smaller excess capitalization also leads to decreases in market-to-book ratios. Lower leverage has, however, reduced the cost of bank debt