Abstract
Empirical studies of banking risk, be it at the institution or sector level, typically focus on either the relationship of competition to risk or bank capital adequacy to risk, but only a subset of studies integrate the two. Lack of integration entails potential bias arising from omission of relevant control variables, and accurate assessment of the interrelations is particularly important in the light of the introduction of a regulatory leverage ratio alongside risk-adjusted capital adequacy in Basel III, as well as macroprudential surveillance and policy which seeks to forecast, assess and control risk at a sectoral level. To advance the literature, we provide estimates for the relation between capital adequacy, bank competition and four measures of aggregate bank risk for different country groups and time periods. Our modelling approach uses control variables that capture aspects of banks’ business models that contribute to financial stability, aggregated to the level of the banking sector. We use macro data from the World Bank’s Global Financial Development Database over 1999–2015 for up to 112 countries globally. We contend that use of macro data means our results are of particular relevance to regulators undertaking macroprudential surveillance, because such data gives a greater weight to large systemic institutions than the more commonly-used bank-by-bank data. Results largely support “competition-fragility”, i.e. a positive relation of competition to risk controlling for capital; both capital measures controlling for competition are significant predictors of risk, but signs vary across risk measures; the leverage ratio is just as widely relevant as the risk-adjusted capital ratio; and there are some differences in results between advanced countries and emerging market economies. Finally, we find competition drives capital ratios lower in a Panel VAR.
Highlights
Empirical studies of banking risk typically focus on either the relationship of competition to risk or bank capital adequacy to risk, but only a subset of studies integrate the two
Baseline regression results using the leverage ratio for capital adequacy on the global sample are shown in Table 4, with the outcome for regulatory capital entered instead of the leverage ratio shown as a memo item
Looking at the results for the non-performing loans (NPLs)/loans ratio in Table 5, we find in the full sample, as already seen in Table 4, both leverage and regulatory capital are significant as is the Lerner index with a negative sign
Summary
Empirical studies of banking risk typically focus on either the relationship of competition to risk or bank capital adequacy to risk, but only a subset of studies integrate the two. We undertake empirical research which assesses the effectiveness of an aggregate leverage ratio relative to a measure of the risk-adjusted capital ratio in affecting banking-sector risk given competition. Our modelling approach is to choose banking sector independent variables that characterise aspects of banks’ business models that contribute to financial stability, aggregated to the level of the banking sector, as used in the key competition-risk study of Beck et al (2013). We utilise both appropriate single equation methods (Logit and Generalised Method of Moments (GMM)) and Panel VectorAutoregressive (Panel VAR) approaches
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More From: Journal of International Financial Markets, Institutions and Money
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