Norges Bank

Staff Memo

Optimal capital adequacy ratios for Norwegian banks

Kasper Kragh-Sørensen
Staff Memo

Banking crises are very costly to society. Higher capital levels improve banks' capacity to bear losses and avoid crises. However, banks' owners may consider increasing equity to be costly and therefore opt to hold insufficient capital. They may, for example, have expectations that banks will be bailed out by the authorities in a crisis. For society, on the other hand, it will be profitable to ensure that banks hold sufficient capital to absorb substantial losses. Calculations of optimal capital levels for Norwegian banks suggest that the economic benefits of increasing capital ratios from current levels are higher than the costs. In line with a number of international studies, we also find that Norwegian banks' Common Equity Tier 1 (CET1) ratio should be higher than the European Commission's proposed minimum requirement of 4.5 percent. The results of our analysis indicate that the optimal level of the CET1 ratio (excluding the Basel I transitional floor) for Norwegian banks is between 13 and 23 percent. Experience from the 1988 –1993 banking crisis indicates that such estimates are not unreasonable. There is considerable uncertainty attached to the calculations. However, the analysis is based on a number of assumptions without which our estimates of optimal capital levels would have been higher.

Staff Memos present reports and documentation written by staff members and affiliates of Norges Bank, the central bank of Norway. Views and conclusions expressed in Staff Memos should not be taken to represent the views of Norges Bank.

ISSN 1504-2596 (online)

Published 20 December 2012 10:00
Published 20 December 2012 10:00