Accounting standard-induced regulatory capital management: evidence from the new lease accounting standard ASC 842

Abstract

• U.S. banks rely heavily on operating leases. • ASC 842 exerts a downward pressure on the regulatory capital ratios of U.S. banks. • Less well-capitalized banks cut back on lending to adjust their regulatory capital ratios upon adoption of ASC 842. • Contraction of lending in less well-capitalized banks harms local economies. The amount of operating leases for U.S. banks, such as rent paid for bank branches and equipment, is not trivial. As such, the new lease accounting standard, ASC 842, exerts a downward pressure on the regulatory capital ratios of U.S. banks due to the requirement to fully risk-weight capitalized operating lease assets. We therefore expect banks to adjust their regulatory capital ratios upward. Using a difference-in-differences design, we find that less well-capitalized banks (treatment group) increase their Tier 1 capital ratio more than better-capitalized banks (control group) after adopting ASC 842, mainly by reducing lending growth rather than increasing shareholders’ equity. This effect is stronger in treated banks with higher ex-ante operating lease commitments, indicating a lease-induced regulatory capital management. Further, less well-capitalized banks significantly adjust towards an optimal Tier 1 capital ratio, and those that are riskier, pay higher dividends, and are non-advanced approaches banks, show greater adjustments of Tier 1 capital ratio and more pronounced declines in lending growth. Finally, we show evidence that suggests the contraction of lending in less well-capitalized banks harms local economies. Overall, the evidence in this study suggests that banks reveal a preference for shrinking credit growth over raising equity levels in response to the new lease accounting standard, highlighting a potential unintended consequence of operating lease capitalization.