The Wealth Effects of the Risk-based Capital Requirement in Banking: The Evidence from the Capital Market

The imposition of risk-based capital requirements has been advocated by some regulatory authorities as a means of mitigating the incentive problems created by fixed-premium deposit insurance. However, their imposition also constitutes a requirement to maintain an exogenously influenced capital structure, which may adversely affect the values of the firms involved. This paper examines the wealth effects of the announcement of the Basle Committee's intention to impose, across international boundaries, a pre-determined minimum level of risk-adjusted capital. We find that, in general, the equity values of a sample of large, publicly traded banks decrease at the time of the announcement. Further, those banks with capital levels which are deficient relative to the mandated levels suffer the largest relative losses.