Law of the Market, Generic Behavior of Capital and the Vicious Circle of Bank Capital Regulation

65 Pages Posted: 4 Dec 2006

See all articles by Hrishikes Bhattacharya

Hrishikes Bhattacharya

Indian Institute of Management (IIM), Calcutta

Date Written: September 2006

Abstract

Capital-assets ratio (CAR) of banks is uniquely determined by the ROA/ROE ratio. This is validated from a study of US banks for the period, 1935-2004. ROE was negatively related to CAR before introduction of capital regulation in US banks but the relationship has turned positive during post-regulation period due to arbitrary rise of capital ratio which increased the required ROE and consequently ROA. The unprecedented rise in ROA of US banks during post-regulation period has increased the risk of the system, which is now in the midst of a vicious circle of more capital - more ROE - more ROA - more risky assets and again more capital.

Keywords: Equity, Bank capital, Market Law, Capital regulation, Risk

JEL Classification: G18, G21, G28, G32

Suggested Citation

Bhattacharya, Hrishikes, Law of the Market, Generic Behavior of Capital and the Vicious Circle of Bank Capital Regulation (September 2006). Available at SSRN: https://ssrn.com/abstract=949019 or http://dx.doi.org/10.2139/ssrn.949019

Hrishikes Bhattacharya (Contact Author)

Indian Institute of Management (IIM), Calcutta ( email )

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