The Moderating Effects of Capital Regulation and Supervisory Power on the Risk-Sensitivity of Bank Capital Requirements

Abstract

Based on bank data from 61 of the largest banks in Asia and the Middle East, this paper presents an analysis of the effects that capital regulation and stringent supervisory actions have on the extent to which bank capital requirements are risk sensitive. While bank-specific factors, namely banks’ buffer, deposit, loans and supervisory power, are statistically-significant, there is no clear evidence to prove that capital regulation and GDP growth rate affect the risk sensitivity of banks. Using a robust one-step system GMM estimator, our results indicate that stricter supervisory power combined with capital regulatory regimes does enhance the risk sensitivity of banks. Our findings have two policy implications. First, the extent to which risk-based capital requirements are effective at controlling bank risk acts independently of the capital requirements set by authorities. Second, bank-specific factors have a more significant impact on risk at the bank level than external factors. To supervise and manage bank-risk level, there is a distinct requirement, at least in emerging economies, for regulators to monitor the operation and performance of banks in addition to verifying their compliance with capital requirements.