Dávila and Walther (2020) argue in their theoretical paper that large banks leverage more because they are aware that their decisions affect bailout policies. Dávila and Walther suggest that the optimal regulation features size-dependent policies that disproportionately restrict large banks’ leverage. This is exactly what the G-SIB and O-SII regulations do even though the G-SIB and O-SII scores also include other indicators than bank size. Thus, larger banks are required to have more capital than smaller banks because they are systemically more important. Hence, on the one hand, they may leverage more, but on the other hand, they have more strict capital requirements.
We use the Significant Bank Database to take a look on the solvency in large banks. We measure a bank’s solvency by using two measures: the total equity-to-total asset ratio and the regulatory capital ratio. The latter is the risk-weighted capital ratio whereas the former is the non-risk-weighted ratio measuring a bank’s equity relative to its balance sheet size.
The figure on the left displays a scatter plot showing the relationship between the total equity-to-total asset ratio and the logarithm of total assets (n = 2015) over the 2009–2023 period. On the right, a similar scatter plot illustrates the relationship between the total capital ratio and bank size (n = 1958). Both ratios are expressed as percentages. The negative relationship between size and capital is more pronounced for the equity ratio than for the total capital ratio. This visible difference is partly due to the presence of larger outliers (and thus, a different y-axis scale) in the total capital ratio data, even though its regression coefficient (-0.92) is slightly smaller in magnitude than that of the equity ratio (-1.19).
Tests for statistical significance indicate that these relationships are indeed statistically significant. However, concluding that large banks leverage more due to moral hazard would be premature, as this bivariate analysis provides only descriptive evidence. Large banks typically have more diversified operations compared to smaller banks, which may reduce their need for capital buffers. Moreover, differences in risk management practices between large and small banks could also help explain the observed patterns.
If you’re wondering about the outliers: the highest equity-to-assets ratio (80.28%) belongs to Nordea Eiendomskredit in 2009 (“eiendom” means real estate in Norwegian). For the total capital ratio, the most extreme outlier is JP Morgan AG—JP Morgan’s German subsidiary—in 2018, with an exceptionally high value of 183.1%. It is also worth noting that there are negative values observed for both the equity ratio and the total capital ratio.
References
Dávila, E., & Walther, A. (2020). Does size matter? Bailouts with large and small banks. Journal of Financial Economics, 136(1), 1–22.
