The Impact of Regulation of Banks in the US and the EU -15 Countries

The regulation of financial markets and banking industry has become one of the most discussed topics by both academics and practitioners in recent years. One of the reason is the fact that bank capital requirements play a prominent role in sustaining financial stability. There are different theories that have rivaling predictions about how banks adjust their risk and capital behavior to imposed regulatory constraints. This paper intends to contribute to these discussions as it tries to evaluate regulatory pressure on selected banks around the world in the 2000-2005 period. To our knowledge, we are the first to test and compare the capital and risk behavior of US banks and banks from the EU 15 region in this period. In order to provide our analysis, we estimate a modified version of the simultaneous equations model developed by Shrieves and Dahl. This model analyzes adjustments in capital and risk at banks when they approach the minimum regulatory capital level. In the model, regulatory pressure is one of the explanatory variables and the dependent variables are changes in risk and capital. There are many methods that can be used to estimate the model; we have chosen the method of two-stage least squares (2SLS) and three-stage least squares (3SLS) estimates in order to test for the robustness of the results. The results indicate that regulatory requirements have the desired effect on bank behavior. We find that both European and US banks close to the minimum regulatory threshold tend to increase their capital adequacy by increasing their capital. Finally, we observe a positive and significant relationship between capital levels and risk exposure for both US and EU banks.