Review of Finance Advance Access originally published online on March 22, 2007
Review of Finance 2008 12(2):391-429; doi:10.1093/rof/rfm007
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What Caused the Bank Capital Build-up of the 1990s?*
1 University of Florida
2 Booz Allen Hamilton
Large U.S. banks dramatically increased their capitalization during the 1990s, to the highest levels in more than 50 years. We document this buildup of capital and evaluate several potential motivations. Our results support the hypothesis that regulatory innovations in the early 1990s weakened conjectural government guarantees and enhanced bank counterparties' incentives to monitor and price default risk. We find no evidence that a bank holding company's (BHC's) market capitalization increases with its asset volatility prior to 1994. Thereafter, the data display a strong cross-sectional relation between capitalization and asset risk.
JEL Classification: G21, G28
* We thank an anonymous referee and the editors, Joel Houston, Mike Ryngaert, M. Nimalendran, Ed Ettin, George Kaufman, Joe Mason, Manju Puri, Jean-Charles Rochet, James Thomson, Larry Wall, and seminar participants at Stanford University, the Federal Reserve Banks of Cleveland, New York, and San Francisco, the University of Kentucky, Tilburg University, Catholic University, the Federal Reserve Bank of Chicago Bank Structure Conference, 2003 AFA annual meetings, the 2002 WFA meetings, and the 2002 EFA meetings for helpful comments on an earlier draft. Tony Saunders and Berry Wilson graciously provided us their data from Saunders and Wilson (1999) for the first 93 years of Figure 1.
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