THE CONSOLIDATION OF THE FINANCIAL SERVICES INDUSTRY
Bank Capital and Bank Structure: A Comparative Analysis of the US, UK and Canada
This study investigates a 100-year history of the asset-risk and capital structure choices of publicly-traded banks located in the UK, Canada and the U.S. These three countries were chosen because of their diverse regulatory and banking structures, while sharing common legal and cultural institutions. For example, the U.S. has historically fostered small banks, and a regulatory system split between national and state regulators. In constrast, Canada has sought financial-sector stability through a small number of large nationally-branched banks that have acted cooperatively with bank rescues during periods of crisis, prior to the presence of their central bank. Finally, the UK established an early tradition of internationally-diversified banking assets and developed a "life-boat" support system orchestrated by the Bank of England. These differences in bank structures and regulatory framework form the basis of our analysis.
The study documents the secular decline in bank capital ratios that has occurred in each country over the past 100 years, and tests various hypotheses concerning how differences in bank risk-taking, the value of bank charters, bank consolidation and extent of safety net guarantees impact capital structure choices. Several broad conclusions follow from the study's results. First, stronger safety net guarantees, such as lender-of-last-resort and liability guarantees, appear to account for much of the historical decline in capital levels, and in particular that component of capital that is independent of a bank's choice of asset risk-taking. We hypothesize that absent strong safety-net guarantees banks were compelled to hold "reserve" levels of capital that served to absorb unexpected capital lossees and provide enhanced liquidity to liability-holders. Interestingly, the study finds that risk-sensitive capital levels in the 1990s are comparable to those found in the 1890s across all three countries, despite considerable differences in bank system structure.
Second, despite significant increases in the
provision of safety-net guarantees within each country, the study finds that bank
asset-risk choices in the 1990s are comparable to those observed in earlier decades.
In constrast, the study documents dramatic increases in bank equity volatililities across
the three countries, with approximately a 10-fold increase equity volatilities over the
100-year period. The increased equity volatility appears to be mostly related to the
decline in bank capital (increase in leverage), rather than to changes in asset risk
choices. Therefore, the study fails to link the provision of government guarantees
to moral-hazard-driven increases in asset risk taking, despite the regulatory-regime
transitions over the study period from relatively unregulated to more highly-regulated
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