Bank’s Optimal Capital Decision And Risk-taking Behaviors With Capital Regulations And The Structural Effects Of Monetary Policy

The 2008 U.S. subprime mortgage financial crisis has triggered a severe global economic recession. Banks were the main victims of the crisis, suffering high-speed increasing of non-performing loans, dramatically shrinking of their assets, and even going bankrupt. The crisis made it urgent for the policy makers to strengthen banks’ capital supervision, therefore Basel III emerged.Banks can absorb losses by their capital to achieve a self-adjustment when facing external shocks. Capital and reserves constrain banks’ behaviors, as long as there are capital regulation and imperfect financial markets. Banks’ capital level also affects the impact of monetary policy, resulting in a structural effect.Based on an optimal capital model and an asset selection model, the thesis theoretically analyzes the typical bank’s capital decision and risk-taking behaviors. Using the GMM approach and panel data of 134 Chinese banks, we empirically examine the impact of capital regulation on capital and portfolio of China’s banks.Our study has shown that capital regulation is crucial for banks’ capital decision and risk behaviors. The impact of capital regulation on capital buffers is stronger than that of the total capital. As the regulatory pressure increases, this effect heightens gradually. Capital regulation can significantly reduce the overall risk level of bank industry. The impact of the current and Tier I capital is greater than that of the capital of the previous and total capital. Also, capital regulation influences more foreign, joint-stock and city commercial banks. A higher statutory deposit reserve ratio leads to more loans of large banks, and the higher capital ratio is, the more loans increase. The scenario in small and medium banks is opposite. Moreover, small and medium sized banks are more sensitive to the adjustment of statutory deposit reserve ratio. All results are statistically significant.We conclude that supervisors and banks should focus on the Tier I capital. Banks must form a long-term mechanism to supplement capital by a way of surplus and others. In addition, the central bank should fully take the different impact of the capital regulation and the structural effects of monetary policy into account, and distinguish the regulation measures to maximize the role of the monetary policy in the stability and adjustment of the financial system and the whole economy.