Bank Portfolio Allocation: The Impact of Capital Requirements, Regulatory Monitoring, and Economic Conditions

Posted: 16 Aug 2001

Abstract

This paper develops a structural, dynamic model of a banking firm to analyze how banks adjust their loan portfolios over time. In the model, banks experience capital shocks, face uncertain future loan demand, and incur costs based on their proximity to regulatory minimum capital requirements and the intensity of regulatory monitoring. Implications of the model are then estimated using panel data on large US commercial banks operating continuously between December 1989 and December 1997. The estimated model is then used to simulate the optimal bank response to (a) past and proposed changes in capital requirements, (b) changes in regulatory monitoring intensity, and (c) economic downturns. The simulation results are used to shed light on the decline in loan growth and the rise in bank capital ratios witnessed over a decade ago, as well as shed light on the possible impact of the current proposed modification to capital requirements.

Keywords: Credit crunch, capital requirements, bank portfolio allocation, Basel Accord

JEL Classification: G21

Suggested Citation

Furfine, Craig, Bank Portfolio Allocation: The Impact of Capital Requirements, Regulatory Monitoring, and Economic Conditions. Available at SSRN: https://ssrn.com/abstract=277088

Craig Furfine (Contact Author)

Kellogg School of Management - Department of Finance ( email )

Evanston, IL 60208
United States

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