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How Do Large Banking Organizations Manage Their Capital Ratios?, a research paper from the Kansas City Fed.

The authors “find strong evidence that target capital ratios decrease with BHC [Bank Holding Company] size and increase with the volatility of BHC earnings (risk). The relationships between capital targets and BHC market value, growth strategy, and business mix are less systematic and statistically weaker.”

I note that by comparing Table 3, Panel A (regressions on leverage ratio) with Table 3, Panel B (regressions on Tier 1 Ratio) it appears that an asset size of greater than $50-billion (comprising 5.4% of the sample) had a statistically significant influence on the calculation of the targetted Tier 1 ratio, but was insignificant when calculating the targetted Leverage Ratio.

Note a 2003 Comment Letter from the State of New York Banking Department stated:

Capital ratios as well as business plans tend to be different at LCBOs [Large Complex Banking Organizations] and smaller banks. Compared to community and regional banks, LCBOs tend to have capital ratios that are closer to the well-capitalized minimums (see Table 1). All five of the New York State banks with assets over $45 billion have leverage ratios between 5.4% and 6.2%, while the range for all banks is from 5.3% to 52%.[1] (The leverage ratio is more constraining than the risk-based capital ratios.) Thus, bifurcation seems to address the concern of LCBOs to manage their capital ratios, while acknowledging that most community and regional banks are comfortable with much higher than required capital ratios.

However, the situation for large regional banks may be somewhat different: the12 New York banks with assets between $5 billion and $45 billion tend to have higher capital ratios than the largest banks, but may be feeling market pressure to manage these ratios. For these institutions, opting in to the A-IRB approach could make it possible to maintain the same risk-based capital ratios while lowering their leverage ratio close to 5%. As IRB systems and software become more developed, opting in may make more sense for these banks, especially since sophisticated credit risk modeling systems also allow more risk-sensitive pricing.

This entry was posted on Wednesday, July 23rd, 2008 at 5:09 pm and is filed under Interesting External Papers. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.