Corporate governance and bank regulation: The impact on capital ratios

Abstract

Regulation and corporate governance are able to influence the banks’ capital optimization problem, therefore impacting changes in capital ratios and risk exposure. Capitalization of banks has become a hot issue during the latest financial crisis that had its peak in 2008, and a key component in the review of the regulatory framework. This study aims at evaluating the influence of regulatory constraints and corporate governance in determining changes in capital ratios and risk levels in banking institutions. To test the hypotheses a panel of European banks from 2006 to 2010 is analyzed. 3SLS is used as estimation technique to account for possible endogeneity problems. Results overall suggest that regulatory pressure and corporate governance act as complementary forces on capital and risk adjustments, although the strength and sign of the governance variables remain unclear. This is one of the first studies to analyze capital and risk decisions taking into consideration both corporate governance and regulation in a unified framework for a sample of European banks operating across the latest financial crisis.