The Role of Market Discipline on Bank Capital Buffer: Evidence from a Sample of European Banks

Abstract

Using a sample of European commercial banks over the period 1993-2006, we show that market discipline significantly and positively affects banks' capital buffer. By distinguishing junior from senior debt holders, we find that both types of investors exert a pressure on banks to hold more capital but that the pressure exerted by junior debt holders is higher. Furthermore, junior debt holders exert a pressure on banks whatever the importance of their non-traditional activities. By contrast, we find that senior debt holders exert a pressure only on banks that are heavily involved in non-traditional activities that are badly taken into account in the current bank capital regulation framework. These results might help us to better understand the role of market discipline as a complement to capital regulation.