Does regulation only bite the less profitable? Evidence from the too-big-to-fail reforms

Staff working papers set out research in progress by our staff, with the aim of encouraging comments and debate.
Published on 29 October 2021

Staff Working Paper No. 946

By Tirupam Goel, Ulf Lewrick and Aakriti Mathur

Profitability underpins the opportunity cost of shrinking assets and the ability to generate capital. It thus shapes banks’ responses to higher capital requirements. We present a stylised model to formalise this insight and test our theoretical predictions on a cornerstone of the too-big-to-fail reforms. Leveraging textual analysis to identify the treatment date, we show that less profitable banks reduced their systemic importance as intended by regulation. Those close to the regulatory thresholds that determine bank-specific capital surcharges – a source of exogenous variation in the regulatory treatment – shrunk by even more. In contrast, more profitable banks continued to expand.

Does regulation only bite the less profitable? Evidence from the too-big-to-fail reforms

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