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This paper tests a two-part hypothesis: First, that during the period between publication of the risk-based capital requirements in early 1989 and the end of 1992, bank holding companies (BHCs)faced a statistically significant decrease in stock returns if they issued new common stock; second, that this discouraged nay common stock issuance and therefore, in effect, forced BHCs with Tier I and/or leverage capital-to-assets ratios below the regulatory minima to decrease loans outstanding more than did BHCs deficient only in their total capital ratios. Empirical evidence supporting both parts of the hypothesis is presented.
In December 1992, pursuant to the Basle accord, capital requirements for banks and bank holding companies (BHCs) changed. For the first time, the minimum amount of capital that a banking organization was required to hold depended on the riskiness of its asset portfolio as well as its size. Various types of assets were assigned weights, according to their perceived riskiness, with commercial loans receiving the highest weight and U.S. government securities the lowest. Banks and BHCs were required to hold at least 4 percent of their risk-weighted assets in so-called Tier 1 capital and 8 percent of their risk-weighted assets in Tier 1 plus supplementary (Tier 2) capital, which includes, for example, mandatory convertible debt and subordinated debt. For BHCs, the bulk of Tier 1 capital was required to be common shareholders' equity plus retained earnings. In addition to the new risk-based requirements, a new minimum Tier 1 capital-to-unweighted asset ratio of 4 percent was established.
When the new capital requirements were first made public in early 1989, some BHCs found themselves in a potentially deficient position. In order to meet the various new capital requirements by the December 1992 deadline, they would have to increase capital and/or decrease riskweighted, or perhaps unweighted, assets. Some of the BHCs deficient in Tier 1 capital found that they would have to increase common shareholders' equity in particular or decrease assets. However, it has been well established that for a variety of firm types, the announcement of the intention to issue common stock tends to decrease a firm's stock value. This paper finds that this type of effect also existed for BHCs in the period following publication of the new capital requirements. The paper then...