Capital requirements, the cost of financial intermediation and bank risk-taking: Empirical evidence from Bangladesh

Abstract

In the aftermath of the global financial crisis of 2007–2009, the Basel III based capital regulation has been emphasized to ensure financial stability. Critics, however, argue that stringent capital requirements may force banks to increase the cost of financial intermediation. In addition, banks may adjust capital ratios and portfolio risk upward simultaneously increasing the overall financial fragility. In this backdrop, we investigate the impact of capital regulation on the cost of financial intermediation and bank risk-taking behavior using a panel data-set of 32 Bangladeshi commercial banks over the period of 2000–2014. We find that bank capital adequacy ratios have a positive association with the cost of financial intermediation, whereas a negative association with bank risk-taking variables. Results remain same when we use equity to total assets ratio as an alternative measure of bank capital. We also observe that an increase in bank income diversification and management efficiency decreases the cost of financial intermediation. Surprisingly, the banking market structure and GDP growth have no measurable impact on the cost of financial intermediation and bank risk-taking behavior. Finally, we draw important implications for bank regulators in general, and for the Central Bank of Bangladesh in particular.