Capital Adequacy Regulation Research Articles

Effect of Capital Adequacy on Operational Efficiency of Commercial Banks in Kenya

This study investigates the impact of capital adequacy on the operational efficiency of Kenyan banks, highlighting its importance for financial stability and risk management using a two-step analytical approach: first, Stochastic Frontier Analysis was used to determine operational efficiency scores for each bank; second, a panel Generalized Method of Moments (GMM) regression model assessed the relationship between these scores and capital adequacy. The study employed a panel GMM Method, accounting for individual and time-specific effects as well as endogeneity and correlation biases. The study concentrated on data from 2008 to 2022, from verified audited financial statements from the Central Bank of Kenya and the respective banks' websites. The study revealed a positive relationship between capital adequacy and operational efficiency. Specifically, increased capital adequacy was associated with a 10.32% improvement in operational efficiency. The study also found that market structure plays a significant role in this relationship. Based on these findings, policymakers should adopt comprehensive strategies focusing on stringent capital adequacy regulations to enhance bank performance and stability.

The concept of banking capital risk-sensitivity revisited

The article studies the foundations of the risk-sensitivity concept of regulatory banking capital. The author states that risk of losses, including unexpected ones covered in accordance with the concept by banking capital cannot be measured with satisfactory accuracy. This is the principal obstacle to the concept implementation. The efficacy of Basel III capital regime with parallel use of risk-sensitive and risk-insensitive approaches is under scrutiny. Rationales are adduced that under this regime risk-sensitive approach has no real value. The study of risk-sensitive approach abilities among macro-prudential tools leads to the conclusion that its efficiency is apparently insufficient. The analysis of the academic study on the issue is carried out. This research recommends to impose risk-sensitive capital requirements if the risk of bank assets can be measured quite accurately. It is shown that the study is based on the implicit assumption of the absence of unexpected losses phenomenon in banking activity. This assumption is unrealistic and makes research in effect objectless. The major inference from the study is that the regulatory capital risk-sensitivity concept is not well-founded and its use for capital adequacy regulation is inadvisable. For micro-prudential purposes the simple leverage deems more expedient. It is capable to ensure for capital regulation the reasonable balance of risk-sensitivity to failure, simplicity and comparability.

Banking system stability in crisis periods: The impact of the banking regulator independence

Local and global financial crises are caused by a wide range of geopolitical, macro-financial, and socio-economic determinants. The purpose of this study is to assess the role of central bank independence in preventing financial crises and mitigating their consequences. Two hypotheses were tested. A measure of the banking regulator independence is the CWN index of the central bank independence. The hypotheses were tested on data from 53 countries suffering from financial crises over the last 40 years (the sample includes both developed and developing countries from different continents). The tools of nonlinear logit regression (modeling the probability of loss of financial stability due to a financial crisis, considering different levels of the banking regulator independence) and panel regression with random effects (modeling the influence of the banking regulator independence on banking activities during crisis periods) were used for calculations. The study did not confirm that a high level of central bank independence is a necessary condition for preventing the occurrence of financial crises in the national economy. On the contrary, the likelihood of financial instability was found to be higher in countries with more independent central banks. Thus, during crisis periods, an increase in the CWN index by 1 ensures an increase in the regulatory capital adequacy parameter by an average of 0.28%, a decrease in return on assets by 0.59%, and an increase in the share of non-performing loans by 1.69%.

Do board characteristics moderate capital adequacy regulation and bank risk-taking nexus in Sub-Saharan Africa?

PurposeThe purpose of this paper is to examine whether board characteristics moderate the relationship between capital adequacy regulation and bank risk-taking of universal banks in Sub-Saharan Africa (SSA).Design/methodology/approachThe paper uses 700 bank-year observations of universal banks in SSA between 2009 and 2019. The paper further uses the two-step generalized method of moments as the baseline estimator.FindingsThe paper finds that capital adequacy regulation is positively related to overall bank and liquidity risks. Nonetheless, capital adequacy regulation increases credit risk in the sampled banks. The paper further reports that board characteristics individually and significantly moderate the relationship between capital adequacy regulation and risk-taking.Practical implicationsThe findings have implications for regulators of universal banks that board characteristics matter for capital adequacy regulation to impact risk-taking behavior.Originality/valueThe paper extends the existing literature on the effect of board characteristics on the capital adequacy regulations and risk-taking behavior nexus of universal banks.

Do Banks Conduct Earnings Management Prior to Seasoned Equity Offerings to Meet Capital Adequacy Regulation?

Do Banks Conduct Earnings Management Prior to Seasoned Equity Offerings to Meet Capital Adequacy Regulation?

Capital ideas: optimal capital accumulation strategies for a bank and its regulator

We formulate a continuous-time model of a deposit taking bank, operating subject to capital adequacy regulation, and where the bank's loans are exposed to default risk. The bank maximises its market value of equity by appropriately controlling loan and equity issuance, dividend payments, and endogenous closure. Of interest to regulators, we show how the bank responds to the span of capital adequacy requirements and to changes in default variance. We find a nonmonotonic response of bank lending to increased capital requirements (initially increasing and then decreasing). We also find that the probability of early closure (through either insolvency or endogenous closure) can be minimised for a well-chosen capital adequacy ratio. Moreover, the level of capital requirement that minimises the probability of early closure and maximises lending is fairly robust to changes in the bank's default variance/risk; contributing to the ongoing discussion on optimal bank capital.

Управління власною ресурсною базою АТ АКБ «ЛЬВІВ»

Abstract. Introduction. The normal development of market relations requires an effectively functioning banking sector, through which the links between all participants and components of the economic mechanism of the state economy can be realized. The key prerequisite for the stable operation of the banking system and ensuring its implementation of the function of financial intermediation is the effective formation of the resource base of banks. Because commercial banks are the centers of the financial system, which concentrate the financial resources of depositors and open access to sources of borrowed resources to borrowers, thereby contributing to the development of the real sector of the economy. For the effective functioning of the bank requires constant analysis of its resource base. Therefore, this article is devoted to the study of the essence of the concept of «bank equity"» from the point of view of the system approach and the analysis of management of own capital of banking institution on the basis of the reporting of JSCB Lviv during 2017-2020. Purpose. The purpose of the article is to highlight the features of managing the bank's own resource base and study of issues of formation of bank resources, their use, assessment of the system of formation and management of bank resources and development of recommendations on ways to improve the effective functioning of this system. Results. The article considers and defines the essence of the concept of bank equity in accordance with the Law of Ukraine. The functions of bank capital are given and characterized. The efficiency of managing the banking institution's own resource base on the example of JSCB «Lviv» is analyzed. The current state of equity development of JSCB «Lviv» in Ukraine is considered and studied. A dynamic and structural analysis of the main indicators that characterize the own potential of the banking institution. The key standards that relate to the bank's own resources base are presented. The level of compliance of the JSCB Lviv with the economic standards set by the National Bank of Ukraine, namely the dynamics of regulatory capital and the regulatory capital adequacy ratio of JSCB Lviv for 2018-2021, is analyzed. »During 2019-2020. The importance of such an indicator as a capital multiplier is considered. The problems of formation and use of the bank's own resources are identified and measures to improve the management of the bank's resource base are proposed. Conclusions. This study will understand what factors affect the ability of banking institutions to effectively conduct banking operations and provide services, as well as the financial stability of the banking system, its place and role in economic transformation and further development of the economy on a market basis, the movement of Ukraine's banking system. society. Dynamic and structural analysis of the main indicators that characterize the bank's own potential will allow to establish the financial stability, reliability and capital adequacy of the bank.

Risks. Senses. Capital. On the concept of banking capital risk-sensitivity

The paper considers selected issues of prudential banking capital adequacy regulation. Current regulatory concept (Basel III) is based on the parallel usage of risk-sensitive and risk-insensitive approaches with the decisive role of the former. The paper provides a comparative analysis of their strengths and weaknesses in the context of capital regulation targets. The conclusion is that there is no notable advantage of either of the two approaches: the risk-sensitive approach as much as the risk-insensitive one is not able to ensure theoretically and/or empirically well-founded measuring of total regulatory capital needs. The risk-sensitive approach evolution leads to increased complexity and resource requirements for banks and regulators. The view is grounded that the advanced risk-sensitive approach (IRB) creates unfair regulatory advantages for IRB-banks and impair competition in banking industry. The practicability of the risk-sensitive approach application for capital adequacy regulation is put under doubt.

Regulation of Cyber Risk in the Banking System: A Canadian Case Study

Abstract Cyber risk is one of the greatest threats facing any modern financial system; a result of increasing dependence on technology and the appeal of troves of personal data to well-equipped hackers. This article examines the governance of cyber risk in the Canadian banking system in the context of the Covid-19 crisis, which has led to a surge in cyber-attacks. It argues that the existing Canadian regime, which draws heavily on the Basel operational risk framework, is unfit to handle the unique challenges posed by cyber risk. Cyber incidents are unlike traditional operational disruptions in both their dynamism and impact, and are not adequately captured by backward-looking proxies, such as historical losses. There is also a mismatch between the traditional risk-based supervision, which relies on annual risk rating of banks, and the quickly changing cyber profile of regulated entities. Furthermore, the bilateral and institution-specific nature of such supervision leaves out the crucial systemic perspective on cyber risk. This article calls for the current quantitative paradigm, which underlies capital adequacy regulation, to be complemented with a resilience-centric approach aimed at better accommodating and learning from unpredictable cyber incidents. This shift requires revisiting traditional supervisory practices, such as extensive reliance on centralized decision-making and planning—which may prove ineffective in the face of a firm-wide cyber incident—and a dynamic approach that keeps regulation in line with emergent knowledge. The article outlines a number of strategies which can help banks and regulators navigate and adapt to the ever-changing cyber landscape.

Identifying the Core Driver for the Islamic Banking Capital Adequacy Regulation

Introduction: COVID-19 pandemic raised the stability challenges for the modern banking systems. As a remedy, the regulators and investors turned their eyes to the Islamic Banking. Many people view it as a full substitute to the dominant conventional banking establishments. We hypothesized that the benefits of the Islamic Banking can be fully enjoyed if and only if it is accompanied with the robust regulatory framework. Such a framework could offer room for the national discretion to define ‘alpha’ parameter within the capital adequacy ratio. The novelty of our paper is the largest collected to date set of alpha value embedded in the Islamic Banking jurisdictions. Purpose: This research paper aims to able to identify the core driver to locally determine the value of alpha. The credit-to-GDP ratio was shown to be such a driver. We demonstrated that the earlier academic research had offered the Vasicek-based theoretical models for the Islamic Banking that had implied right the opposite values of alpha. Methodology: We have eight independent determinants with presenting the alpha values for 11 countries registered in 2007 and in 2016.Those are the four macroeconomic variables. we have collected the input data for the regression model. Findings: The credit-to-GDP ratio was shown to be such a driver. We demonstrated that the earlier academic research had offered the Vasicek-based theoretical models for the Islamic Banking that had implied right the opposite values of alpha. Thus, the usage of the determinant revealed by us could be of help to the central bankers when shaping the framework for Islamic Banking capital adequacy. Paper Type: Research Article

Agent-based modeling for benchmarking banking regulation regimes: Application for the CBDC

COVID-19 pandemic challenges the sustainability of the modern financial system. International central bankers claim that banks are solid. They have accumulated significant capital buffers. Those buffers should be further more augmented by 2027 in line with Basel III reforms. However, disregarding such a consecutive rise in the banking capital adequacy requirements, the US financial authorities undertook an unprecedented step. First time in the country history they lowered the reserve requirement to zero at the end of March 2020. Friedrich von Hayek demonstrated the fragility of the modern fractional reserve banking systems. Together with Ludwig von Mises (von Mises, 1978) he was thus able to predict the Great Depression of 1929 and explain its mechanics much in advance. Thus, we wish to utilize the agent-based modeling technique to extend von Hayek’s rationale to the previously unstudied interaction of capital adequacy and reserve requirement regulation. We find that the full reserve requirement regime even without capital adequacy regulation provides more stable financial environment than the existing one. Rise in capital adequacy adds to modern banking sustainability, but it still preserves the system remarkably fragile compared to the full reserve requirement. We also prove that capital adequacy regulation is redundant when the latter environment is in place. We discuss our findings application to the potential Central Bank Digital Currencies regulation.

Bank Risk Capital and Its Effectiveness in Selected Euro Area Banking Sectors

Risk capital or capital at risk (CaR) refers to the amount of capital set aside and maintained by banks to cover different types of risk. For banks, it is used as a buffer against claims or expenses in the event that ordinary capital is not enough to cover them. Thereby, risk capital can also be recognized as risk-bearing capital or surplus funds. Risk capital may generate very high costs, but on the other hand it protects against insolvency. That’s why a bank needs to find the ‘Gold mean’—the optimal value of risk capital that will not lower its efficiency, but still ensure financial security. The main objective of the study is identification of interdependencies between bank risk capital and effectiveness of the aggregated Eurozone banking sector and selected national banking sectors of the euro area. The paper tries to answer the research question whether the risk capital supports or lowers banks’ operational effectiveness. The adopted research hypothesis stated that there is a positive correlation between profitability and size of bank risk capital. To verify the hypothesis regression models were used. The results indicate that the size and structure of bank capital impact on the credit institutions’ effectiveness in the analyzed banking sectors, however with different intensity. Thereby, the article fulfils a research gap in the field of research studies that take into account how capital at risk and specific capital adequacy regulations may impact on a bank’s efficiency.

Implementation of Internal Capital Adequacy and Assessment Process in Vietnamese Commercial Banks

The internal capital adequacy and assessment process (ICAAP) was first introduced in the second pillar of Basel II in 2004 to offset the deficiencies of Basel I and capital adequacy regulations in the first pillar of Basel II. This process is aimed at identifying and measuring risks generated in banks’ activities, and then provides the requirements for internal capital levels and methods to raise capital to deal with these risks. In fact, the implementation of Basel II and ICAAP in Vietnamese commercial banks has attained notable achievements, but it also revealed some major weaknesses. The purpose of this research is to evaluate the implementation of ICAAP in Vietnamese commercial banks in eight components of the ICAAP addressed by Basel II using the survey method and then to simulate the implementation of ICAAP in a Vietnamese commercial bank. From the facts and the simulation of the ICAAP framework in this study, the authors offer some suggestions for Vietnamese commercial banks to implement ICAAP effectively in their banking operations.

Regulatory Capital is a Panacea for Efficiency, Credit Growth and Reducing Non-Performing Loans in Commercial Banks

This study examined the effectiveness of regulatory capital in enhancing efficiency and credit growth and reducing bad loans in commercial banks listed on the Pakistan Stock Exchange (PSX) from 2010 to 2019. Precisely, the impact of capital adequacy ratio (CAR) was studied on net interest margin (NIM), credit growth (CR) and non-performing loans (NPLs). The impact of capital adequacy regulations was assessed by retrieving data from financial statements analysis (FSA), Bank Financial statements and the World Bank website. Panel regression models including ordinary least squares (OLS), fixed and random effects under robust title were applied in this study. Results revealed that the implementation of stringent CAR plays the role of panacea and increases interest margin & credit growth and a reduction of NPL in Pakistani commercial banks. The study provides practical results for regulators to customize regulations on credit growth to reduce non-performing loans and maintain healthy growth of loans by not compromising on interest margins as well as maintenance of minimum capital adequacy ratios. With the high significance of stringent minimum capital adequacy for banks, the findings of the study are valuable for regulators, banks, auditors and investors, as capital adequacy ratio commonly plays the role of Panacea in terms of efficiency, credit growth and reduction in non-performing loans. Keywords: capital adequacy ratio, efficiency, credit growth, non-performing loans

Bank-Specific Variables and Banks’ Financial Soundness: Empirical Evidence from Nigeria

Abstract This study examines the explanatory power of capital adequacy, asset quality, management soundness, earnings quality, liquidity and sensitivity to market risk (CAMELS) framework as well as a number of other variables on the financial soundness (measured by regulatory capital adequacy ratios) of banks in Nigeria. The findings, using ordinary least squared (OLS) regression subsequent to the establishment of no panel effects among the sampled banks, reveal the significant explanatory potentials of these bank-specific variables though some give a reversal of their prior expectations. Apart from reawakening the investors’ and depositors’ interest, the findings further have policy implications on the regulation and operation of these financial institutions. The study breaks new grounds in the measurement of capital adequacy using gross revenue ratio and leverage ratio, asset quality using income statement impairment charges for loan losses, and in the inclusion of the sensitivity to market risk most especially in the Nigerian context.

The effect of the balance sheet approach on the usefulness of accounting information in assessing bank default risk

This study investigates the effect of the balance sheet approach, where financial reporting focuses on asset and liability valuation, on the usefulness of the capital adequacy ratio in the evaluation of bank default risk by credit rating agencies. We examine Japanese banks, which play the central role in the Japanese economy, and whose capital adequacy ratios are affected by the fair value measurement under the balance sheet approach. We adopt Demerjian’s (2011) approach to develop a bank-level measure of balance sheet focus. Although we find a significant positive correlation between the slack of the regulatory capital adequacy ratio and issuer rating, we find that this positive correlation is significantly weakened as a bank’s dependence on the balance sheet approach increases. The results suggest that the regulatory capital adequacy ratio based on a bank’s accounting information provides useful information for the evaluation of default risk but that rating agencies discount capital information that relies heavily on the balance sheet approach when estimating a bank’s default risk.

Unrecognized Expected Credit Losses and Bank Share Prices

ABSTRACTAccounting for credit losses under U.S. GAAP is transitioning from an incurred to an expected loss model. The model change was motivated by concerns that reporting only incurred losses does not provide investors with sufficient and timely information about banks’ credit risk. In this paper, I develop a measure of lifetime expected credit losses using vintage analysis to examine whether stock prices reflect information about unrecognized expected credit losses in an incurred loss regime. Consistent with investors being able to obtain information about expected losses that are not recognized in the financial statements, I find that unrecognized expected credit losses are negatively associated with bank stock prices. The pricing of these losses is stronger for larger banks, consistent with lower costs of obtaining this information for banks with better information environments. I also find that recorded allowances were less than estimated expected losses, on average, consistent with concerns that implementing the expected loss model will adversely impact regulatory capital adequacy.

Capital Adequacy Regulation and Financial Distress Resolution in the Nigerian Banking Industry: An ARDL Approach

This paper investigates the impact of capital adequacy regulation on financial distress resolution in the Nigerian banking industry within the ARDL framework using aggregate time series data. Financial distress resolution is measured by ratio of distressed banks, while capital adequacy regulation is measured by credit to risk weighted assets ratio, capital to total assets ratio and assets to capital ratio. The sample comprises annual time series data covering the period from 1986 to 2018, while the data are obtained from three reliable sources: namely, Central Bank of Nigeria (CBN) statistical bulletin, Nigeria Deposit Insurance Corporation (NDIC) quarterly and Nigeria Stock Exchange (NSE) fact sheet. The plausible ARDL specification is determined using the Schwarz information criterion, which selects a model with two lagged values of ratio of distressed banks as additional explanatory variables. We find that financial distress resolution exhibits persistence behavior and depends on its two lagged values, but with a positive and sizable net own effect. However, the relationship between financial distressed resolution and capital adequacy regulation measures has no lagged effect. Also, both the individual and joint impacts of the three capital adequacy regulation ratios are not statistically significant. Based on these findings, we conclude that capital adequacy regulation is not an important determinant of financial distress resolution in Nigeria, and that the regime of risk-based capital regulation may produce further moral hazards behavior in the Nigerian banking sector.

Liquidity Management, Basel Capital Adequacy and Financial Distress Resolution in the Nigerian Banking Industry

The purpose of this study is to analyze the effect of liquidity management and BASEL capital adequacy on financial distress resolution in Nigeria. The study adopts a unidirectional causal research design within the single-equation dynamic autoregressive distributive lag (ARDL) framework. The empirical analysis is based on annual time series data covering the period from 1986 to 2018 obtained from different Central Bank of Nigeria (CBN) statistical bulletin and Nigeria Deposit Insurance Corporation (NDIC) quarterly as well as the factsheet of the Nigerian Stock Exchange (NSE). The stationarity test results indicate that the study variables are integrated at different levels, with most of them being I(1) series. The ARDL results show that micro-prudential liquidity management has no significant effect on ratio of distressed banks, while the effect of macro-prudential liquidity management on ratio of distressed banks is significant. The results also show that capital adequacy regulation has no significant effect on both ratio of distressed banks and governance/compliance breaches of distressed banks, while it has a significant effect on business risks exposure of the distressed banks and asset quality of distressed banks. Further, monetary policy measures have no significant effect on the level of distress in the Nigerian banking industry. Based on these findings, we conclude that in Nigeria, prudential measures aimed at achieving macro-level financial sector stability have significant policy implications for financial distress resolution. Also, while traditional monetary policy measures are not effective tools for achieving financial sector stability, the effect of capital adequacy regulation on financial distress resolution depends on how the former is measured. The main contribution of this study is the use of Newey-West robust framework, which consistently estimated the effect of liquidity management and BASEL capital adequacy on financial distress resolution even when both heteroskedasticity and autocorrelation are present in the data.

COMMODITY PRICE SHOCKS AND FINANCIAL SECTOR STABILITY IN COMMODITY DEPENDENT COUNTRIES IN SOUTHERN AFRICA

This paper examines the impact of negative commodity price shocks on financial sector stability in selected Southern African countries, namely Angola, Botswana, Mozambique, Namibia, Tanzania, Zambia and Zimbabwe. Using multivariate panel data regression analysis, with fixed effects from 2000 to 2015, the study shows that commodity price downturns result in increased non-performing loans and reduced bank profitability. Specifically, negative commodity price shocks reduce profitability as measured by the return on assets and return on equity. In addition, the study shows that there is an adverse impact on financial sector conditions, using a financial condition index as a proxy. The index was derived from a combination of measures of non-performing loans, return on assets and regulatory capital adequacy ratios, using a three variable dynamic factor model. The main transmission mechanisms through which commodity prices shocks affect financial stability are GDP growth, fiscal revenue, savings and the size of the fiscal deficit.