How Do Large Banking Organizations Manage Their Capital Ratios?

U. S. banks hold significantly more equity capital than required by their regulators. We test competing hypotheses regarding the reasons for this "excess" capital, using an innovative partial adjustment approach that allows estimated BHC-specific capital targets and adjustment speeds to vary with firm-specific characteristics. We apply the model to annual panel data for publicly traded U. S. bank holding companies (BHCs) from 1992 through 2006, an extended period of increasing bank capital that ended just before the subprime credit crisis of 2007-2008. The evidence suggests that BHCs actively managed their capital ratios (as opposed to passively allowing capital to build up via retained earnings), set target capital levels substantially above well-capitalized regulatory minima, and (especially poorly capitalized BHCs) made rapid adjustments toward their targets.