How do banks manage their capital during uncertainty?

ABSTRACT

The paper investigates the impact of EPU on bank capital in the U.S. from 2001–2020. The empirical results show that banks hold more capital when encountering high EPU. This effect increases with the bank size, meaning that the larger banks hold more capital during increasing EPU. Interestingly, further analyses reveal that worst-capitalized banks decrease their capital ratio when EPU elevates. The results are robust under different econometric methods and alternative proxies of uncertainty and bank capital.

KEYWORDS:

• Bank capital
• banking
• crisis
• economic policy uncertainty

JEL CLASSIFICATION:

• G21
• G28
• G34
• G38

Acknowledgments

Dung Tran gratefully acknowledges the financial support of the National Foundation for Science and Technology Development of Vietnam (NAFOSTED).

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

¹ Proxies for macroeconomic uncertainty include (i) VXO index, (ii) GDP forecast dispersions, (iii) macroeconomic uncertainty index of (Jurado, Ludvigson, and Serena 2015), (iv) cross-sectional standard deviations of profit growth. See (Tran and Houston 2021) for further details. We also add these proxies one-by-one into our specification. In all specifications, our results remain unchanged.

² We also use the residual EPU from estimating EPU as a function of the Canadian EPU and other macroeconomic variables and find similar results.

³ We also use the Tier 1 capital over risk-weighted-assets, the excess of capital over the regulatory requirements, and still find similar results.

⁴ We also perform our specification with (i) only the 4th quarter data, (ii) excluding banks that engage M&A, (iii) excluding crisis periods, (iv) lag of different periods of independent variables, (v) alternative econometric approaches: Prais-Winstein, Newey-West, Cluster 2-way. In all specifications, we obtain similar findings.

⁵ We also use the weighted average, the quarterly median of EPU, and subsamples of different types of banks. We obtained the same results.

Additional information

Funding

This work was supported by the Vietnam National Foundation for Science and Technology Development (NAFOSTED).