Banks’ capital buffer, profitability and risk of failure: the effect of regulation, supervision and the business cycle

In this article, we apply the GMM technique on dynamic panels, using both bank-level data and country-level data for the three largest European economies (Germany, the UK and France) during the period 2005-2013 to investigate the impact of regulation, supervision and the business cycle on capital buffers, banking profitability and the risk of failure. Our results provide three major findings. First, the regulation indicators have a negative impact on bank profitability. When the supervisory authority imposes restrictions on banking activities, managers become more risk-averse, the bank's risk-taking decreases and, as a consequence, profitability decreases. Second, the measures adopted by the Basel Committee on Banking Supervision (the Basel III Accord) regarding the management of capital buffers over the business cycle are very important in order to fortify the banking system's stability. Third, regulation and supervision perform differently, depending on the indicators of profitability and the risk of failure.