Nonlinearity of Bank Capital and Charter Values∗

Several potential sources of nonlinearity have been predicted by the theoretical literature relating to bank capital, risk taking and charter values. This paper empirically explores the predicted long-run relationships for a set of United States (US) bank hold-ing companies (BHCs) between 1986 and 2008. We find that the relationship between capital buffers and charter values is highly non-linear and ‘hump ’ shaped. In particular, we show that once banks have a charter value above the median threshold, their cap-ital buffer is held constant. This is in contrast to the prediction that larger charter values will induce banks to hold larger capital buffers. Moreover, we show that as the charter value decreases, banks build up their buffers. As the charter continues to fall, the relationship is however always reversed.