July 11, 2014

Bank recapitalization

Banks have to increase their capital ratios to meet the new regulation requirements. This can be achieved through raising new equity capital or by reducing bank assets. Banks often opt for the second channel due to the higher private costs of equity issuance. This, however, is associated with high public costs.
Main image

In this CPB Background Document we discuss the welfare costs of undercapitalized banks and review the empirical literature. Undercapitalized banks are bad for the economy mainly for two reasons. The first is misallocation of credit resulting from banks gambling for resurrection and reluctance to recognize losses. The second is contraction of credit supply driven by banks reducing their assets to increase their capital ratios. In this respect, we describe the experience in previous financial crises.

Further, we analyze the potential private costs of bank recapitalization through equity issuance from a theoretical and empirical perspective. We perform an event study on bank equity issuance in the EU and US for the period 2007-2013. The results show a significant negative effect of SEOs on bank stock prices. However, this effect is on average not extreme and is comparable with other events. The negative effect on stock prices is partially compensated by a significant reduction of banks’ funding costs proxied by CDS spreads.

The analysis concludes with a discussion of the appropriate policy options to enhance bank recapitalization.

Downloads

English, Pdf, 1.5 MB

Contacts

Kristina Marinova Read more
Foto Sander van Veldhuizen
Sander van Veldhuizen +31 6 11648608 Read more
Gijsbert Zwart Read more

Read more about