The impact of capital on bank profitability during the COVID-19 pandemic

Abstract

This study examines how various forms of capital in the years leading up to the COVID-19 pandemic affected bank profitability during the crisis in emerging economies. Using data from 819 banks in 26 countries during the 2019–2020 period, we find that banks entering the crisis with a superior capital position performed better during the pandemic. High-quality capital metrics such as Tier 1 capital and total regulatory capital ratios, not the standard leverage ratio, possess the capacity to affect bank profitability. These results are robust after controlling for Basel III liquidity requirements. We also find that the capital-profitability relationship is stronger for larger banks and for those that entered the crisis with better liquidity and credit risk position. Overall, our results imply that focusing on capital quality can help reduce the adverse effect of an external shock on bank performance.