Banks' buffer capital: how important is risk

Most banks hold a capital to asset ratio well above the required minimum defined by the present capital adequacy regulation (Basel I). Using bank-level panel data from Norway, important hypotheses concerning the determination of this buffer capital are analyzed. Focus is on the importance of: (i) risk, (ii) the buffer as an insurance, (iii) the competition effect, (iv) supervisory discipline, and (v) economic growth. A negative or non-significant risk effect is found, which suggests that introducing a more risk-sensitive capital regulation (Basel II) is likely to affect Norwegian banks. Support is found for the hypothesis that buffer capital serves as an insurance against failure to meet the capital requirements. (C) 2004 Elsevier Ltd. All rights reserved.