De-Risking Through Equity Holdings: Bank and Insurer Behavior Under Capital Requirements

Using a sample from 1980 to 2018, we find evidence consistent with banks and insurers in the U.S. diversifying financial risk through their equity holdings. They tend to offset the risk of increased leverage by lowering the leverage of the non-financial firms in which they take an equity stake. We attribute this finding to the impact of risk-based capital regulations. Facing the high cost of equity, financial institutions are well incentivized to comply with increased capital requirements by reducing asset risk. Our results demonstrate that the scope of the induced de-risking activities of these institutions is not limited to their credit portfolios but extends to their equity exposure as well. We also show that non-financial firms that are concerned about being dropped from the portfolios of financial institutions could de-leverage to deviate from their theoretically optimal capital structures. These novel regularities need to be included in debates about capital regulations for banks and insurance companies.