The empirical research of banks' capital buffer and risk adjustment decision making

Abstract

PurposeIn order to improve banks' ability to fight against risks, China's financial regulatory authorities refer to the Basel Accord, and bank capital adequacy ratio is taken as an important means of control. The purpose of this paper is to investigate the internal mechanism between capital buffers and risk adjustment.Design/methodology/approachBased on the dynamic characteristics of a bank's continuing operations, the authors established an unbalanced panel of China's commercial bank balance‐sheet data from 1991 to 2009 and used the Generalized Method of Moments to examine the relationship between short‐term capital buffer and portfolio risk adjustments.FindingsThe authors' estimations show that the relationship between capital and risk adjustments for well capitalized banks is positive, indicating that they maintain their target level of capital by increasing (decreasing) risk when capital increases (decreases). In contrast, for banks with capital buffers approaching the minimum capital requirement, the relationship between adjustments in capital and risk is negative. That is, low capital banks either increase their buffers by reducing their risk, or gamble for resurrection by taking more risk as a means to rebuild the buffer. Moreover, the authors' estimations show that the management of short‐term adjustments in capital and risk is dependent on the size of the capital buffer.Research limitations/implicationsFrom the current research documents, there are few empirical researches on capital buffers and risk adjustment, and the research sample time limits of current papers are a little earlier. The researches did not reflect China's commercial banks' capital buffer and risk adjustment after the new Basel Accord.Practical implicationsBanks' adjustment speed of target level depends on the size of capital buffer, proving that the speed of adjusting capital buffer of banks with smaller capital buffer is significantly faster than their counterparts with larger capital buffers.Originality/valueThe paper uses the dynamic feature of banks' lasting operations as the logical starting point, which is ignored by the current researches, and investigates the internal mechanism between capital buffers and risk adjustment.