Abstract
This paper uses quantitative modeling methods to assess the potential impact of the new capital requirements defined in Basel III and Capital Requirements Directive IV on European banks. In our analysis we explore the impact of the higher capital requirements on the level of profitability of European banks.
More specifically, we try to pinpoint which of the variables, whether increased interest rates resulting from the higher cost of capital, or the decreased risk of undertaken operations, will have the most significance. Based on the results of our analysis which employs a simultaneous equations model on 594 banks operating in the European Union in the period 2006-2011, we conclude that higher capital requirements under the Basel III proposal would cause a decrease in banks' profitability accompanied by a drop in their risk taking.
Additionally, we show that a higher level of capital held by banks would cause them to decrease their risky assets held relative to total assets.