Working Paper No 671
By Belinda Tracey, Christian Schnittker and Rhiannon Sowerbutts
We use provisions for misconduct issues as an instrumental variable to identify the causal effect of bank capital on risk-taking. Misconduct provisions can adversely affect bank capital via their negative impact on retained earnings, and we find evidence of this for UK banks. We also find strong support for our assumption that misconduct provisions are otherwise unrelated to risk-taking. We facilitate our analysis with a new UK panel dataset of bank-level information including misconduct provisions, merged with loan-level data on all regulated UK mortgages. Our main finding is that a negative bank capital shock leads to an increase in risk-taking.