Discussion Paper

Bank Capital and Risk: Cautionary or Precautionary?


Abstract: Do riskier banks have more capital? Banking companies with more equity capital are better protected against failure, all else equal, because they can absorb more losses before becoming insolvent. As a result, banks with riskier income and assets would hopefully choose to fund themselves with relatively more equity and less debt, giving them a larger equity cushion against potential losses. In this post, we use a top-down stress test model of the U.S. banking system?the Capital and Loss Assessment under Stress Scenarios (CLASS) model?to assess whether banks that are forecast to lose capital in a severe downturn do indeed have more capital, and how the relationship between capital and risk has evolved over time.

Keywords: Bank Capital; Stress Testing; Financial Stability;

JEL Classification: G2;

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Bibliographic Information

Provider: Federal Reserve Bank of New York

Part of Series: Liberty Street Economics

Publication Date: 2015-02-02

Number: 20150202