Study of optimal capital adequacy ratios

Abstract

In response to international financial developments after the global financial tsunami in 2008, the Bank for International Settlements (BIS) proposed Basel III in 2010, whereby banks have to increase their minimum capital adequacy ratios year by year with a goal of 10.5 % by 2019. This study looks to answer two questions: (1) Is the capital adequacy ratio of 8 % required by Basel II too low to guide banks moving toward the efficiency frontier? (2) Is Basel III’s target capital adequacy ratio of 10.5 % in 2019 so strict that it might impact banks’ efficiency? The dataset herein consists of thirty-one Taiwan commercial banks over the period 2007–2009 for a total of ninety-three observations. The empirical results indicate that as many as 93.5 % of the banks have an optimal capital adequacy ratio greater than the 8 % regulation in Basel II. Approximately 88.2 % of the banks have an optimal capital adequacy ratio higher than 10.5 %. In addition, nearly 73 % of the banks should raise their BIS ratios in order to achieve the optimal BIS ratios. Hence, higher BIS ratios required by Basel III may pilot the Taiwan banking industry to reach the efficiency frontier.