Supranational rules, national discretion : increasing versus inflating regulatory bank capital?

We study how supranational capital regulation incentivizes national authorities to exercise forbearance and how this affects the regulatory capital of banks across countries. Using the 2011 EBA capital exercise as a quasi-natural experiment, we find that banks substantially inflated their levels of regulatory capital via a reduction in "regulatory adjustments"--without a commensurate increase in book equity and without a reduction in bank risk. We show how national authorities forbear their domestic banks to meet supranational requirements, with a focus on short-term economic considerations. Regulatory capital inflation is more pronounced in countries where credit supply is expected to tighten