Capital Constraints and Systematic Risk

Abstract

The market-risk-based capital requirements may result in an additional capital constraint for banking organizations. We examine the systematic risk gap between high and low trading banks, since only banks with sufficiently high trading activities are subject to such additional capital charge, while distinguishing between low and high capital banks. We find that a contribution of a bank’s trading activity to its systematic risk becomes stronger after the new requirements were introduced, but this increase is larger for low capital banks. Our interpretation is that capital-constrained banks are more sensitive to market conditions because they need to make additional balance sheet adjustments in response to market shocks, and that these adjustments can have implications, albeit limited, for other banks, capital constraints of which were initially non-binding.