Optimal capital adequacy ratio for Norwegian banks

Abstract

In this paper, we analyse the appropriate capital adequacy ratio for banks from a socio-economic perspective. More equity capital in banks can contribute to financial stability by reducing the risk of costly banking crises, but lending may become more expensive if banks are required finance their assets with more equity. When assessing optimal capital adequacy ratios, the economic costs of more expensive credit must therefore be weighed against the benefits of fewer and less costly banking crises. Our calculations take into account recent changes in bank capital regulation. The results indicate that Norwegian banks should have a Common Equity Tier 1 (CET1) ratio of between 12 and 19 percent. The current CET1 ratio of around 18 percent is in line with this. Our estimates are consistent with results from international studies, but estimates vary considerably with changes in uncertain assumptions. However, banks’ capital needs during the banking crisis in the beginning of the 1990s show that such estimates are not unreasonable.