This paper examines whether climate risk affects the dynamics of banks’ regulatory capital adjustments, based on a large panel of European banks over the 2006–2021 period. Using a dynamic partial adjustment model, we find that climate-exposed banks hold higher capital adequacy ratios and adjust faster toward their optimal capital structure, particularly when exposed to transition risk and post-COP21. Climate risk also induces asymmetric adjustment behaviours. Deleveraging occurs through risk-weighted asset reallocation toward safer exposures, without asset liquidation or lending cuts. While leveraging operates through risk-weighted asset expansion, without reducing equity growth. However, pre-COP21, deleveraging is primarily achieved through lending contraction, whereas leveraging relies mainly on asset expansion. Our findings highlight the policy relevance of climate risk for prudential supervision and bank capital regulation.

Using a novel cross-European dataset on bank internationalization, the paper accounts for organizational and geographic complexity and evaluates its impact on systemic risk and how both the 2008–09 global financial crisis and the 2010–11 European sovereign debt crisis might have modified such an impact. Ahead of the crisis (2005–07), results suggest that bank complexity materially reduces systemic risk and enhances stability, as it encourages banks to take on more diversified risks. While such a relation is inverted during the crisis (2008–11) and after the crisis (2012–13), consistent with the view that, during distress times, international banks have less ability to monitor cross-border risks. Further evidence show that, regardless of the period, the effect of complexity on systemic risk is accentuated for ‘too-big-too-fail’ banks and banks with strong activity diversity. Conversely, complex banks with merger-acquisition history and banks operating networks of foreign branches mitigate systemic risk during the acute crisis and the later stage of the crisis, respectively. The results are robust to the use of alternative measures of systemic risk and complexity, and numerous additional tests. Findings bear critical policy implications for financial regulations.

Frictions prevent banks to immediately adjust their capital ratio towards their desired and/or imposed level. This paper analyzes (i) whether or not these frictions are larger for regulatory capital ratios vis-à-vis a plain leverage ratio; (ii) which adjustment channels banks use to adjust their capital ratio; and (iii) how the speed of adjustment and adjustment channels differ between large, systemic and complex banks versus small banks. Our results, obtained using a sample of listed banks across OECD countries for the 2001–2012 period, bear critical policy implications for the implementation of new (systemic risk-based) capital requirements and their impact on banks’ balance sheets, specifically lending, and hence the real economy.