Webex-seminar: Optimal capital ratios for European banks

In this paper we estimate the optimal level of capital for banks in the euro area. Higher bank capital requirements may be socially costly, as rising funding costs might result in higher lending rates. On the other hand, if increasing bank capital is socially costly, so too is not raising bank capital sufficiently. Reserves help banks absorb financial shocks and thereby reduces the likelihood of banking crises. Our baseline estimates show an optimal capital ratio of around 22 percent. However, we also find substantial heterogeneity across member states. Optimal ratios range from 27 percent for banks in Cyprus to as low as 8 percent in Belgium. This suggests that optimal ratios are likely inversely related to the strength of national economies and the ease with which banks in different member states can raise capital.