Capital regulation, competition and risk-taking behavior of Indian banks in a simultaneous approach

Abstract

PurposeThe 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.Design/methodology/approachSecondary 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 andH-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.FindingsThe 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.Practical implicationsThe 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.Originality/valueThis 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.