Speaker: Michael Ohlrogge, Stanford
I examine whether whether low capital levels incentivize banks to systematically originate and hold riskier loans. I construct a novel data set consisting of 1.8 million small business and home mortgage loans, matched to the specific banks that originated them and the capital levels of those banks at the time of origination, and verified to be held on bank portfolios, rather than sold. A one point increase in capital ratios (e.g. from 12% to 13%) is associated with a 4% decrease in the default risk of mortgage loans held on portfolio (from a net foreclosure rate of 2.5% to 2.4%). Bank capital has macro impacts. When considering the average capital of banks in counties during the pre-crisis period, a one point increase in capital levels is associated with a 2.9% reduction in foreclosures during the financial crisis. A five point increase in capital ratios, which was achieved post-crisis, could have prevented at least 430,000 foreclosures had it occurred earlier. These results are robust to bank and time fixed effects and an instrumental variables strategy for predicting bank capital.