Capital Adequacy, Bank Behavior and Crisis: Evidence from Emergent Economies
02 Jun 2015-European Journal of Sustainable Development (European Center of Sustainable Development)-Vol. 4, Iss: 2, pp 329-338
TL;DR: In this article, the authors examined the impact of capital requirements on bank risk-taking during the recent financial crisis and found that banks close to the minimum regulatory capital requirements improve their capital adequacy by increasing their capital and decreasing their risk taking.
Abstract: Using the simultaneous equations model, this paper examines the impact of capital requirements on bank risk-taking during the recent financial crisis. It also explores the relationship between capital and risk decisions and the impact of economic instability on this relationship. By analyzing the data of 46 commercial banks between 2004 and 2014 from four Middle East countries, the study concludes a positive effect of regulatory pressure on bank capital and bank risk taking. The findings reveal also that banks close to the minimum regulatory capital requirements improve their capital adequacy by increasing their capital and decreasing their risk taking. Furthermore, the results show that economic crisis positively affects bank risk changes, suggesting that banks react to the impact of uncertainty by increasing their risk taking. Finally, the estimations show a positive correlation between banks profitability and increase in capital, indicating that profitable banks can more easily improve their capitalization through retained earnings rather than issuing new securities. Keywords: bank regulation, risk taking, bank capital, crisis.
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TL;DR: In this article, the authors investigated the association between capital regulation and risk-taking behavior of Indian banks after incorporating the influence of competition, and found that absolute level of regulatory capital and bank risk are positively associated.
Abstract: The purpose of this paper is to investigate the association between capital regulation and risk-taking behavior of Indian banks after incorporating the influence of competition. Further, the study intends to enrich the existing literature by providing empirical evidence on the role of human resources in managing risk along with the influence of other bank specific and macroeconomic variables.,Secondary data on 39 listed Indian commercial banks are collected from “Capitaline Plus” corporate data database for a period of 15 years. Capital is measured by capital adequacy ratio as defined by the regulators, and two definitions of risk – credit risk and insolvency risk – are employed. Competition is measured by Herfindahl-Hirschman deposits index, concentration ratio and H-statistic. The value-added intellectual coefficient model is employed to compute human capital efficiency (HCE). Three-stage least squares technique in a simultaneous equation framework is used to estimate the coefficients.,The study finds that absolute level of regulatory capital and bank risk are positively associated, although the influence of capital on risk is not statistically significant. The influence of competition on risk is negative for all the models, which supports the “competition stability” view. The impact of human capital on bank risk is also negative for all cases.,The findings of the study are useful for the decision makers in several ways based on the inverse influence of competition and HCE on bank risk. Further, the observed positive association between capital and risk indicates that the capital regulation is not sufficient to enhance the stability in the banking sector.,This is the first study in the Indian context that incorporates the competition in the banking industry as an explanatory variable in the extant bank capital and risk relationship.
19 citations
TL;DR: In this paper, the effect of regulations of central bank on performance of commercial banks in Rwanda using Rwanda commercial banks as the case study was assessed using STATA programming to get progressively point by point results.
Abstract: The purpose of this study was to assess the effect of regulations of central bank on performance of commercial banks in Rwanda using Rwanda commercial banks as the case study. A descriptive design was used and the target population was eleven licensed commercial banks in Rwanda.A census was conducted to obtain secondary data from commercial banks as well as review of information from central bank's annual audited reports for the period 2010 to 2015. The data obtained was processed and analyzed using STATA programming to get progressively point by point results. The study found that capital adequacy regulation affects performance of commercial banks in Rwanda positively and this influence was found to be significant. The study concluded that capital adequacy positively and significantly influences financial performance suggesting that an increase in capital adequacy regulations within a bank will result in financial improvements in the bank. The study recommended that banks should comply entirely with the stipulated regulations since this will ensure a stable banking sector which plays a major role in the economy.
12 citations
Cites background from "Capital Adequacy, Bank Behavior and..."
...The first visibility came with the efforts of the Federal Financial Institutions Examination Council to have the federal bank regulators formulate a common definition of bank capital(Alkadamani, 2015)....
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16 Feb 2018
TL;DR: In this article, an attempt to empirically explore the association of capital adequacy and insolvency risk of Indian Commercial Banks, while controlling for various other bank specific and macroeconomic factors which also affects the risk level of the banks.
Abstract: This paper is an attempt to empirically explore the association of capital adequacy and insolvency risk of the Indian Commercial Banks, while controlling for various other bank specific and macro-economic factors which also affects the risk level of the banks. To find the inter-relationship of Capital Adequacy Ratio (CAR) and insolvency risk, data of 21 years and 43 banks have been taken into consideration. Simultaneous Equations Model (SEM) is used to examine the association between Risk and Capital Adequacy Ratio and Two Stage Least Squares (2SLS) method is being used to estimate the parameters of the Simultaneous Equations Model. The findings reflect that both variables have inverse impact on each other. The other micro and macro-economic variables also have significant impact on risk and capital of the banks.
5 citations
01 Sep 2020
TL;DR: In this article, the interlinkage of different banking sector variables, viz. capital adequacy ratio, profitability, risk, efficiency and other controlled variables, was investigated with data for the period 1996-2016 and 43 Indian Commercial Banks.
Abstract: The changing paradigm of the banking sector regulation has prompted to investigate the inter-linkage of different banking sector variables, viz. capital adequacy ratio, profitability, risk, efficiency and other controlled variables. The study is designed with data for the period 1996–2016 and 43 Indian Commercial Banks. The result of two-stage least squares method reflects that CAR bears a positive association with the risk taking behaviour of the banks. Second, it has been seen that CAR is having a positive association with profitability, but it is adversely associated with efficiency.
5 citations
TL;DR: In this paper, the authors study banks' optimal equity buffer in general equilibrium and their response to under-capitalization and provide a novel rationale for macro-prudential capital regulation and new testable implications about banks' capital structure management.
Abstract: We study banks optimal equity buffer in general equilibrium and their response to under-capitalization. Making progress towards a pecking order theory for private recapitalizations, our benchmark model identifies equity issuance as individually and socially optimal, compared to deleveraging, as well as conditions that invert the individually optimal ranking. Imperfectly elastic supply of capital, incomplete insurance markets and costly bankruptcies give rise to inefficiently high leverage ex-ante, and to excessive capital shortfalls and insolvencies ex-post. Abstracting from moral hazard and informational asymmetries, we therefore provide a novel rationale for macroprudential capital regulation and new testable implications about banks capital structure management.
3 citations
Cites background from "Capital Adequacy, Bank Behavior and..."
...…evidence consistent with the observation that banks recapitalize through share issuance is available from studies focusing on German (Memmel and Raupach 2010), Swiss (Rime 2001), British (Ediz et al. 1998), European (Kok and Schepens 2013) and Middle Eastern banks (Alkadamani 2015)....
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References
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TL;DR: This article examined the relative importance of many factors in the capital structure decisions of publicly traded American firms from 1950 to 2003 and found that the most reliable factors for explaining market leverage are: median industry leverage, market-to-book assets ratio (−), tangibility (+), profits (−), log of assets (+), and expected inflation (+).
Abstract: This paper examines the relative importance of many factors in the capital structure decisions of publicly traded American firms from 1950 to 2003. The most reliable factors for explaining market leverage are: median industry leverage (+ effect on leverage), market-to-book assets ratio (−), tangibility (+), profits (−), log of assets (+), and expected inflation (+). In addition, we find that dividend-paying firms tend to have lower leverage. When considering book leverage, somewhat similar effects are found. However, for book leverage, the impact of firm size, the market-to-book ratio, and the effect of inflation are not reliable. The empirical evidence seems reasonably consistent with some versions of the trade-off theory of capital structure.
2,380 citations
Book•
01 Jan 1997
TL;DR: In this paper, the authors provide a comprehensive treatment of the microeconomic theory of banking and finance, with a focus on four important topics: the theory of two-sided markets and its implications for the payment card industry; "non-price competition" and its effect on the competition-stability tradeoff and the entry of new banks; the transmission of monetary policy and the effect of the credit market of capital requirements for banks; and the theoretical foundations of banking regulation, which have not yet led to a significant parallel development of economic modeling.
Abstract: Over the last thirty years, a new paradigm in banking theory has overturned economists' traditional vision of the banking sector. The asymmetric information model, extremely powerful in many areas of economic theory, has proven useful in banking theory both for explaining the role of banks in the economy and for pointing out structural weaknesses in the banking sector that may justify government intervention. In the past, banking courses in most doctoral programs in economics, business, or finance focused either on management or monetary issues and their macroeconomic consequences; a microeconomic theory of banking did not exist because the Arrow-Debreu general equilibrium model of complete contingent markets (the standard reference at the time) was unable to explain the role of banks in the economy. This text provides students with a guide to the microeconomic theory of banking that has emerged since then, examining the main issues and offering the necessary tools for understanding how they have been modeled. This second edition covers the recent dramatic developments in academic research on the microeconomics of banking, with a focus on four important topics: the theory of two-sided markets and its implications for the payment card industry; "non-price competition" and its effect on the competition-stability tradeoff and the entry of new banks; the transmission of monetary policy and the effect on the functioning of the credit market of capital requirements for banks; and the theoretical foundations of banking regulation, which have been clarified, although recent developments in risk modeling have not yet led to a significant parallel development of economic modeling. Praise for the first edition:"The book is a major contribution to the literature on the theory of bankingand intermediation. It brings together and synthesizes a broad range ofmaterial in an accessible way. I recommend it to all serious scholars andstudents of the subject. The authors are to be congratulated on a superbachievement." -- Franklin Allen, Nippon Life Professor of Finance and Economics, WhartonSchool, University of Pennsylvania "This book provides the first comprehensive treatment of the microeconomicsof banking. It gives an impressive synthesis of an enormous body ofresearch developed over the last twenty years. It is clearly written and apleasure to read. What I found particularly useful is the great effort thatXavier Freixas and Jean-Charles Rochet have taken to systematicallyintegrate the theory of financial intermediation into classicalmicroeconomics and finance theory. This book is likely to become essentialreading for all graduate students in economics, business, and finance." -- Patrick Bolton, Barbara and David Zalaznick Professor of Business, Columbia University Graduate School of Business "The authors have provided an extremely thorough and up-to-date survey ofmicroeconomic theories of financial intermediation. This work manages to beboth rigorous and pleasant to read. Such a book was long overdue and shouldbe required reading for anybody interested in the economics of banking andfinance." -- Mathias Dewatripont, Professor of Economics, ECARES, Universit
1,904 citations
TL;DR: In this article, the authors consider the effect of share price changes on market-valued leverage and conclude that firms do have target capital structures, as opposed to market timing or pecking order considerations, which explains a majority of the observed changes in capital structure.
Abstract: The literature provides conflicting assessments about how firms choose their capital structures, with the "tradeoff", pecking order, and market timing hypotheses all receiving some empirical support. Distinguishing among these theories requires that we know whether firms have long-run leverage targets and (if so) how quickly they adjust toward them. Yet many previous researchers have relied on empirical specifications that fail to recognize the potential impact of adjustment costs on a firm's observed leverage. Likewise, few researchers have incorporated the effect of share price changes on market-valued leverage. We estimate a relatively general, partial-adjustment model of firm leverage decisions, and conclude that firms do have target capital structures. The typical firm closes more than half the gap between its actual and its target debt ratios within two years. 'Targeting' behavior as opposed to market timing or pecking order considerations explains a majority of the observed changes in capital structure.
1,556 citations
TL;DR: A more general, partial-adjustment model of firm leverage indicates that firms do have target capital structures as mentioned in this paper, and the typical firm closes about one-third of the gap between its actual and its target debt ratios each year.
1,275 citations
TL;DR: This paper found that the majority of variation in leverage ratios is driven by an unobserved time-invariant effect that generates surprisingly stable capital structures: high (low) levered firms tend to remain as such for over two decades.
Abstract: We find that the majority of variation in leverage ratios is driven by an unobserved time-invariant effect that generates surprisingly stable capital structures: High (low) levered firms tend to remain as such for over two decades. This feature of leverage is largely unexplained by previously identified determinants, is robust to firm exit, and is present prior to the IPO, suggesting that variation in capital structures is primarily determined by factors that remain stable for long periods of time. We then show that these results have important implications for empirical analysis attempting to understand capital structure heterogeneity.
1,166 citations