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11 March 2014

BIS: Banks and capital requirements - Channels of adjustment

This paper examines the broad patterns in how banks have gone about achieving higher risk-weighted capital ratios since the crisis. A key finding: the bulk of the adjustment has taken place through the accumulation of retained earnings rather than through sharp adjustments in lending or asset growth.

The adjustment process to Basel III is not yet complete. The evidence presented here, however, suggests that most banks have achieved most of the adjustment to date through the accumulation of retained earnings. Banks in advanced economies have reduced dividend payouts as part of this process. Banks in emerging economies have enjoyed high earnings and asset growth, and have had little trouble using some of their strong earnings to increase their capital ratios. An additional, though secondary, role has been played by the shift to assets with lower risk weights on the part of advanced economy banks. Banks in advanced economies have benefited from modestly wider net interest margins. Reductions in operating expenses do not appear to have played much of a role.

Banks in aggregate do not appear to have cut back sharply on asset or lending growth as a consequence of stronger capital standards. However, banks that had high capital ratios at the start of the process or strong profitability in the post-crisis years did tend to grow more than other banks. This points to the importance of solid bank balance sheets in supporting lending.

There has been a pronounced shortfall in lending growth on the part of European banks, though European banks have accumulated other assets in the form of cash and securities. Some banks, especially in Europe, have cut back their trading portfolios.

Further research is needed to understand the interplay among these different adjustment strategies, and to trace their macroeconomic effects. It will be especially important to look more closely at the relative roles of regulation, macroeconomic factors, sovereign risk concerns, and the disposal of legacy assets in the balance sheet adjustments that have been made by the European banks.

Working paper

© BIS - Bank for International Settlements

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