Security Holdings, Capital Regulation, and Risk Exposure of Japanese Banks

Abstract

This paper empirically investigates how risk exposure of security holdings affected the optimal choice of total risk weighted asset under Basel II regulation. With costly recapitalization cost, banks optimally choose buffer regulatory capital above the minimum standard. Therefore, security holdings ratio with low risk weight under current regulation increases the optimal risk exposure because marginal cost of recapitalization decreases. This paper provides empirical results consistent with this prediction and demonstrates the simulated negative effect of higher risk weight on the security holdings.