No. 890 - Start-up banks’ default and the role of capital

Regulation requires banks to hold a minimum capital endowment upon their establishment. But what role does initial capital play in a bank's lifecycle? This paper addresses the issue for start-up banks. We use both survival-time and binary choice models for a sample of newly-established Italian banks in the period 1994-2006, controlling for a broad set of possible drivers of default, such as market, managerial and financial variables. Our results suggest that initial capital does play a leading role in explaining both the timing and the likelihood of a failure. Other important drivers are organisation and a balanced growth path, while market and management variables appear to play a minor role. We then turn to a quasi-experimental design: exploiting a regulatory shift in 1999 we run a counterfactual analysis of the impact of a regulatory tightening of initial capital, which affected only a subsample of banks. The set of results suggests that the effect on banks' survival may be significant.