Abstract:
This thesis investigates the relationship between bank capital buffers and business cycle fluctuations. The study examines how a bank constructs its capital buffer, and then tests whether the bank follows Pecking Order Theory or Trade-off Theory. This paper focuses on whether the behaviour of bank capital buffers differs between the United States and Japan. This study employs unbalanced panel data from 2003 to 2011, including a total 5,087 banks. This study applies the Arellano – Bond (1991) difference generalised method of moments model and fixed-effects model to avoid the endogeneity problem in the regression. The empirical results report the bank capital buffers increase in the recession and decrease in the expansion in both the United States and Japan. The change of Tier 1 capital in relation to the total capital buffers ratio is negatively correlated with the business cycle in the Japanese sample. The change of Tier 2 capital to the total capital buffers ratio is negatively related to the business cycle in the U.S sample. The results show that U.S. banks tend to issue debt to build up their capital buffers, whereas Japanese banks prefer issuing equity before debt to accumulate their capital buffer. Based on the studies made by Shyam-Sunder and Myers (1999), this study further investigates whether the bank capital buffer structure favours the pecking order theory in the U.S. sample. The study finds neither the U.S. banks nor the Japanese banks follow the trade-off theory to construct their bank capital buffer structure.
