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Abstract
The study aims to investigate the effect of conventional capital ratio, risk-based capital ratio, and capital buffer ratio on commercial bank risk-taking over the period from 2002 to 2019 using a two-step GMM method. The finding reveals that there is a positive relationship between traditional capital ratio and risk-taking for the full sample results, which is supported by the regulatory hypothesis. The results are same across various categories based on capitalization and liquidity. Whereas the relationship is negative when capital is measured through risk-based capital ratio and capital buffer, the results are in line with the moral hazard hypothesis. The outcomes are consistent for all subcategories other than for well-capitalized and low liquid banks. The full sample findings are consistent when risk is proxied through loan loss provision. The impact of capital ratios on risk-taking in the pre-, pro- and post-crisis eras is heterogeneous and significant. The findings have significant insights for regulators to observe the differences among pre-, pro- and post-crisis periods for the well, adequately, under, significantly under-capitalized, high and low liquid insured commercial banks of the USA.
Highlights
Globalization and technological transformation have encouraged financial institutions to develop innovative financial products to fulfil concerned stakeholders’ requirements
The findings show that the relationship between risk-based capital, capital buffer ratio, and risk-taking is significant and negative, as evidenced by risk-weighted assets
The results show that the traditional capital ratio, risk-based capital ratio, and capital buffer ratios of the well-capitalized banks have no influence on risk-taking, which is consistent with Shrieves and Dahl (1992)
Summary
Globalization and technological transformation have encouraged financial institutions to develop innovative financial products to fulfil concerned stakeholders’ requirements. These developments are accompanied by some risks in the banking sector. The regulators have been trying to provide a universal model to manage the bank capital and risk-taking since Basel-I presented in 1988. It is followed by Basel-II that introduced in 2004. The capital adequacy ratio, which requires 8% of the risky assets. How do capital ratios of the high-liquid banks affect risk-taking differently than low-liquid banks? How does a change in traditional capital ratio, risk-based capital ratio and capital buffer ratio affect a bank’s risk-taking during the post-crisis period in comparison with pre-crisis and pro-crisis period? In a specific manner, how do capital ratios of the well-capitalized banks influence risk differently from adequately and under-capitalized commercial banks? How do capital ratios of the high-liquid banks affect risk-taking differently than low-liquid banks?
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