How Do Capital Buffers Respond to Basel? An Empirical Analysis of the Brazilian Banking System

Abstract

We empirically examine the main determinants of the capital buffer management (capital exceeding the minimum required by regulation) for the Brazilian banking industry, in order to test whether banks respond to the previous and new fundamentals of capital regulation. We find evidence that regulatory capital requirements may influence banks behavior, since those with more volatile earnings and higher adjustments costs may decide to hold higher capital buffers. We also find that banks may follow a pecking order when deciding their capital levels, and larger banks present lower levels of capital ratios, which may be related to too-big-to-fail issues. Moreover, we provide evidence that: (i) Central Bank supervision exerts positive pressure on bank’s decision; (ii) market discipline may play a minor role in driving capital ratios; and (iii) the business cycle has a negative impact on bank’s capital cushion, suggesting a pro-cyclical capital management. The results contribute to the discussion of the implementation in Brazil of the macro-prudential regulatory policies discussed in the Basel Committee.