Did Capital Requirements Promote Bank Stability: Lessons from the National Banking Era

Abstract

The early 20th century United States provides an opportunity to determine whether imposing capital requirements on commercial banks promotes banking stability in the long run. The structure of the national banking system facilitates inference using a regression discontinuity design. The discontinuity arose because federal law raised capital requirements on banks operating in towns whose populations exceeded certain thresholds. These thresholds enable me to estimate the impact of capital requirements on the choices and outcomes of similar banks operating in similar towns under different regulatory regimes. I find that banks subject to higher capital requirements did hold more capital, but also increased their lending proportionately, so that their leverage and risk of failure remained roughly unchanged. Ultimately, capital requirements did not result in lower suspension rates or enhance financial stability.