A Note on the Role of Bank Capital

Authors

  • Alfred V Guender University of Canterbury

DOI:

https://doi.org/10.14738/abr.26.828

Abstract

This note explores how a bank’s balance sheet responds to a capital shock in a simple model of the banking firm where both loan demand and deposits are sensitive to a bank’s capital position relative to its competitors. An unconstrained bank shrinks its deposit base in the wake of a capital loss if loan demand is very sensitive to the bank’s relative capital position. The deposits of an unconstrained bank expand only if both deposit and loan demands are fairly immune to a bank’s relative capital position. In a simple model with reserves we show that in the wake of a capital loss the adjustment of loans and reserves under a binding constraint depends on the parameters of the model while the adjustment of total assets and liabilities does not. Loans decrease by the size of the capital loss plus the increase in reserves. If the constraint is not binding then loans generally decrease by more than the increase in reserves.

Keywords: deposits, loans, reserves, capital-asset ratio, balance sheet JEL Code: E51, G2

Author Biography

Alfred V Guender, University of Canterbury

Associate Professor, Dept of Economics and Finance

References

Arnold, B., C. Borio, L. Ellis, and F. Moshirian. (2012). “Systemic Risk, Macro prudential Policy Frameworks, Monitoring Financial Systems and the Evolution of Capital Adequacy. “Journal of Banking and Finance, 36: 3125-3132.

Berger, A., R. Herring, and G. Szego. (1995). "The Role of Capital in Financial Institutions." Journal of Banking & Finance 19.3-4: 393-430.

Bhattacharya, S. and A.V. Thakor. (1993). “Contemporary Banking Theory”, Journal of Financial Intermediation 3, 2-50.

Peek, Joe and Eric S. Rosengren. (1995). “The Capital Crunch: Neither a Borrower nor a Lender Be.” Journal of Money, Credit and Banking, August, pp. 625-38.

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Published

2014-12-22

How to Cite

Guender, A. V. (2014). A Note on the Role of Bank Capital. Archives of Business Research, 2(6), 9–17. https://doi.org/10.14738/abr.26.828