The Role of Bank Capital in Bank Holding Companies’ Decisions

Abstract

This paper examines the role of bank capital in decision-making by bank holding companies(BHCs) in the United States. Following Chami and Cosimano's (2001) call option approachto bank capital, BHCs optimally choose the amount of capital to insure the bank againstbecoming capital constrained in the future. We provide empirical support for this model, andfind that a higher optimal level of capital leads to higher loan rates. Furthermore, higher loanrates result in lower amounts of lending. Thus, an increase in capital requirements is likely tolead to higher loan rates and a significant reduction in lending.