How Do Capital Ratios Affect Bank Risk-Taking: New Evidence From the United States

Faisal Abbas,Shoaib Ali,Sohail Rizwan,Omar Masood

doi:10.1177/2158244020979678

Faisal Abbas, Shoaib Ali + Show 2 more

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https://doi.org/10.1177/2158244020979678

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Journal: SAGE Open	Publication Date: Jan 1, 2021
Citations: 23	License type: CC BY 4.0

Affiliation: University of Lahore, Air University, University of Malaya

Abstract

This study aims to examine the impact of different capital ratios on Non-Performing loans, Loan Loss Reserves, and Risk-Weighted Assets by studying large commercial banks of the United States. The study employed a two-step system generalized method of movement (GMM) approach by collecting the data over the period ranging from 2002 to 2018. The study finds that using Non-Performing loans and Loan Loss Reserves as a proxy for risk, results support moral hazard hypothesis theory, whereas the results support regulatory hypothesis theory when Risk-Weighted Assets is used as a proxy for risk. The results confirm that the influence of high-quality capital on Non-Performing loans, Loan Loss Reserves, and Risk-Weighted Assets is substantial. The distinctive signs of Non-Performing loans, Loan Loss Reserves, and Risk-Weighted Assets have indications for policymakers. The results are intimate for formulating new guidelines regarding risk mitigation to recognize Non-Performing loans and Loan Loss Reserves and the Risk-Weighted Assets for better results. JEL Classification: G21, G28, G29

Highlights

Since the order of the Basel-I Accord in 1988, followed by Basel II in 2004 and most as of late the Basel III Accord in 2010, the definitions of bank capital has advanced significantly in an exertion to improve banking framework soundness and fill the harmonization hole that had caused past monetary crises
It ought to be quite compelling to experts and regulators in the United States because, from one perspective, a holding of a higher capital ratio intensifies the bank’s loss absorption potential
We develop the following hypothesis: Hypothesis 2: There is a positive relationship between the risk-taking of large commercial banks of the United States and capital ratios

Summary

Introduction

Since the order of the Basel-I Accord in 1988, followed by Basel II in 2004 and most as of late the Basel III Accord in 2010, the definitions of bank capital has advanced significantly in an exertion to improve banking framework soundness and fill the harmonization hole that had caused past monetary crises. Capital fills in as a security component to absorb losses In this way, it ought to be quite compelling to experts and regulators in the United States because, from one perspective, a holding of a higher capital ratio intensifies the bank’s loss absorption potential.

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