Abstract
In this paper we estimate the optimal level of capital for banks in the euro area. This optimum is the result of a trade-off between the costs and benefits of more bank capital: although higher capital requirements likely lead to higher lending rates, they also reduce the likelihood of banking crises. Our baseline estimates show an optimal risk-weighted capital ratio of around 23%. By varying the assumptions underlying our analysis we obtain a range of optimal ratios from 16% to 31%. These estimates are higher than the current Basel III minimum requirements. We also estimate optimal rates for individual member states and find substantial differences between them. This is primarily due to variation across countries in the resilience of their economies. For this reason we find lower optimal bank capital ratios in countries with more stable economies. Our results show only a modest dependence on the ease with which banks in different member states are able to raise capital.
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