Usability of Bank Capital Buffers: The Role of Market Expectations

Usability of Bank Capital Buffers: The Role of Market Expectations
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Volume/Issue: Volume 2022 Issue 021
Publication date: January 2022
ISBN: 9781616358938
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Topics covered in this book

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Banks and Banking , Finance , Economics- Macroeconomics , Economics / General , Capital Buffers , Basel III , Capital Regulation , Financial Institutions , Macropru , valuation model , buffer Usability , market expectation , bank Capital Structure , capital shortfall , Countercyclical capital buffers , Correspondent banking , Loans , Market capitalization , COVID-19 , Global

Summary

Following the COVID shock, supervisors encouraged banks to use capital buffers to support the recovery. However, banks have been reluctant to do so. Provided the market expects a bank to rebuild its buffers, any draw-down will open up a capital shortfall that will weigh on its share price. Therefore, a bank will only decide to use its buffers if the value creation from a larger loan book offsets the costs associated with a capital shortfall. Using market expectations, we calibrate a framework for assessing the usability of buffers. Our results suggest that the cases in which the use of buffers make economic sense are rare in practice.