Capital Adequacy Requirements Research Articles

Bank Financial Performance and its Linkage with Capital: A Dynamic Panel Data Analysis of Public Sector Banks in India

This article empirically investigates the linkage of capital infusion in the Public Sector Banks (PSBs) in India with the capital adequacy, asset quality, profitability, operational efficiency and the market position of the banks. Utilising a balanced panel data of total 21 PSBs over 9 years (2009 to 2017), we analyse the key determinants of the Indian PSBs’ profitability, net interest margin (NIM), solvency and market efficiency. The study applies a two-step dynamic panel generalised methods of moments. We find empirical evidence that the Capital Infusion programme of the Government during 2008–2009 to 2016–2017 has significant impact on the performance of PSBs in India. We have observed that with frequent infusion of capital by the government, banks were able to meet the regulatory Basel II/III capital adequacy requirements and it has positive influence on their market capitalisation as well as NIM. However, capital infusion has an insignificant impact on improving return on assets (ROA) of banks. Our study suggests that a higher common equity tier 1 capital ratio leads to better market reputation and solvency position of the banks. The results of the study provides insight for bank management, regulators and policymakers for improving bank performance and better utilisation of scarce capital and public money. JEL Code: G21, G32, G34

The Effect of Capital Adequacy Requirements on Profitability: An Empirical Study on Licensed Finance Companies in Sri Lanka

Licensed Finance Companies (LFCs) in Sri Lanka are recognized as authorized and regulated financial institutions to accept public deposits. However, with the recent collapse of a few LFCs in Sri Lanka, a serious concern has been raised about whether the LFC sector in Sri Lanka does not expose its shareholders to excessive levels of risk. Accordingly, the primary objective of this study is to examine the relationship between capital adequacy and the profitability of LFCs in Sri Lanka. This study is classified into the quantitative research approach based on secondary data of 18 LFCs in Sri Lanka from 2011 to 2020. The Core Capital Adequacy Ratio (CCAR), Total Capital Adequacy Ratio (TCAR), and LFC size (SIZE) were used as independent variables and as measures of profitability of LFCs, Net Interest Margin (NIM), Return on Assets (ROA) and Returns on Equity (ROE) were considered as dependent variables. The empirical results indicated that NIM, ROA, and ROE are positively related to CCAR, but none was significant. Further, NIM and ROA show a positive relationship with TCAR; however, only a significant relationship between ROA and TCAR was observed. Accordingly, this study recommends that since ROA would be increased in the capital adequacy level of LFC, all LFCs need to develop their internal policies to ensure that they have a clear set of capital adequacy expectations in place.

Financial Regulation, Financial Inclusion and Competitiveness in the Banking Sector in SADC and SAARC Countries: The Moderating Role of Financial Stability

Financial inclusion is a widely used measure to improve the living standards of households and foster inclusive economic growth. Thus, financial inclusion is one of the main policy objectives in developing countries. Besides, financial regulation (capital adequacy requirement) is a policy measure used to ensure financial stability. The objective of this study is to examine the effect of financial regulation on competitiveness and financial inclusion in 15 countries in the SADC (Southern Africa Development Community) region and 8 countries in the SAARC (South Asian Association for Regional Cooperation) region over the period 2005–2018. The result of Feasible Generalized Least Squares (FGLS) estimation suggests that financial regulation reduces competitiveness and hampers financial inclusion in the banking sector in the two regions. Furthermore, we find that financial stability moderates the negative effect of financial regulation on competitiveness and financial inclusion, meaning that financially stable banks remain competitive and normally offer financial products and services even if strong capital adequacy requirements are implemented. Additionally, we find that competitiveness increases financial inclusion in countries in the SADC region. The policy implication of this study focuses on regulatory flexibility to preserve the need for greater financial inclusion in the two regions. As for the practical implication, the study calls for strategic measures to preserve stability such as complementing financial inclusion with financial literacy, fostering corporate governance.

Assessing the economy-wide impacts of strengthened bank capital requirements in Indonesia using a financial computable general equilibrium model

ABSTRACT After the 2008 global financial crisis, authorities across the globe stressed the importance of equity capital to absorb losses. While many countries have raised bank capital adequacy requirements (CARs), the comprehensive impact assessment of this policy for emerging economies remains largely unexplored. We use a financial computable general equilibrium (FCGE) model of Indonesia called AMELIA-F to investigate the economy-wide impact of a 100 basis points increase in the CAR of Indonesian banks. Bank balance sheets contract as they move away from holding riskier assets, aiding macroeconomic stability. However, both non-housing and housing investment contract as banks pass on higher funding costs, driving long-run real GDP below baseline. As we discuss, debt-to-equity ratios for these sectors, and the economy-wide private debt to income ratio all fall, thus aiding long-run macroeconomic stability.

Impact of Capital Adequacy on Bank Stability in Lebanon

This research paper intention is to study the capital adequacy requirements in the Lebanese banks and the effect of this ratio on the financial stability. Capital adequacy ratio and Altmans z-score (representing stability of banks) were collected from a sample of 8 Lebanese banks in the time between 2009 to 2018. The collected data is analyzed using SPSS software to reach conclusions that serves the topic of study. 8 simple linear regressions are conducted, among a confidence level of 95% and a level of error 5%. Each simple regression has a dependent variable (Altman’s Z-score) which represents the stability of the bank, and an independent variable (Capital adequacy ratio). The results show that almost in all banks (except bank MED) there was no significant impact of CAR on the stability of the banks. This result shows that the commitment of Lebanese commercial banks under the monitoring of the central bank was not enough to keep the financial system stable, which is a logical conclusion after what happened in 2019 where the financial system has collapsed and the commercial banks faced a severe crisis in its liquidity and reputation. Although the central bank in Lebanon was in a full compliance with Basel requirements concerning minimum capital over years, the Lebanese banking sector has collapsed and bankrupted. Also, depositors were not protected and they lost their deposited money in the bank. In other words, capital requirements in Lebanon did not prevent banks from engaging in excessive risk-taking and enhance financial stability. Thus, the problem of the Lebanese banking sector could be mismanagement, concentration of the loans portfolio in Eurobonds and with the central bank, and many other factors that caused the financial collapse in Lebanon.

The Effect of Applying Banking Regulations on Banking Performance of MENA Region Countries

This paper attempts to investigate the effect of applying banking regulations on banking performance. This has been conducted on 19 MENA region countries (Egypt, Sudan, Lebanon, Libya, Iraq, Tunisia, Algeria, Morocco, Qatar, United Arab Emirates, Saudi Arabia, Bahrain, Palestine, Oman, Djibouti, Turkey, Kuwait, Jordan, and Mauritania), on a yearly basis over the period from 2008 to 2018.
 Banking regulations have been measured by each of capital adequacy requirements (capital base to risk-weighted assets), liquidity requirements (liquid assets to total assets), legal reserve requirements (balances with CB to banks' deposit), leverage requirements (total equity to total assets) and provisions policy (total provisions to total capital), while Banking performance has been measured by each of banking efficiency using (data envelopment analysis "DEA" & operational efficiency ratio), banking stability (ABSI & Z-score indexes), credit risk ("non-performing loans" & "provisions for non-performing loans") and profitability (return on assets & return on equity).
 Results indicate that there is a significant effect of applying banking regulations on each of "banking efficiency", "banking stability", "credit risk" and "profitability". This has been conducted using panel data analysis according to static panel models (SPM) according to three models (pooled regression, fixed effects, and random effects).

Koncentracija kapitala na tržištu osiguranja i pretpostavke solventnosti

The subject of this paper is the analysis of the concentration of capital on the insurance market in the Republic of Serbia and the identification of critical points in the analysis of insolvency of insurers. The necessity of economic and social protection of the interests of insured persons in conditions when the business of insurance companies is objectively exposed to a large number of risks can be achieved only if insurance companies meet extremely strict solvency requirements. In addition to the requirements for the adequacy of recognized liabilities and capital adequacy requirements, insurance companies are additionally faced with a number of special requirements, including requirements relating to the matching of assets, capital and liabilities. Although capital adequacy is the strongest type of guarantee, ie the ability of the insurance company to settle its future obligations based on claims, payments of insured amounts and other obligations, in essence compliance means that the insurer has additionally met the requirements regarding the amount and relative relations between assets, capital and liabilities, within assets or liabilities, as well as the relative relationship between certain categories of assets and capital and liabilities. The aim of this paper is to point out that for the insurer, in addition to capital adequacy and adequacy of technical reserves, the existence of financial balance is essential, ie the establishment of structural and maturity matching of assets, capital and liabilities. The structure of the paper provides insight into the analysis of capital concentration and fulfllment of capital requirements of insurers operating in the insurance market in Serbia, but also consideration of solvency assumptions and insight into the methodological apparatus used in the process of insolvency and security analysis of insurers.

The Effect of Restructuring the Quality of Earning Assets and Profitability on the Minimum Capital in Rural Banks

This study aims to examine the effect of Non Performing Loans (NPL), Return On Assets (ROA) and Return On Equity (ROE) on the Capital Adequacy Ratio (CAR). As an intermediary institution, rural banks has an obligation to comply with and follow the rules of the Financial Services Authority(OJK). OJK issued the Minimum Capital Adequacy Requirement (MCAR) regulation, which was originally required to be 8% to 12% of Risk Weighted Assets (RWA) with a deadline of the end of December 2019. The emergence of the Covid-19 pandemic has put pressure on rural banks performance due to the increasing threat of bad loans. The OJK issued a national economic stimulus regulation that contained restructuring of the quality of productive assets so that bad loans could be suppressed. By using a sample of 57 rural banks with assets of 3 billion to 35 billion in 2020, the effect is tested using multiple regression. The results of the study simultaneously that NPL, ROA and ROE have an effect on CAR. Partially NPL has a positive effect on CAR, ROA has a negative effect on CAR, ROE has a significant positive effect on CAR.

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.

The Impact of Non-Performing Loans, Return on Assets, Return on Equity, and Loan to Deposit Ratios on Minimum Capital Adequacy Requirement Based on Commercial Banks for Business Activities (BUKU) I 2015-2020

The purpose of this research is to gain an understanding of The Impact of Non-Performing Loans, Return on Assets, Return on Equity, and Loan to Deposit Ratios on Minimum Capital Adequacy Requirement Based on Commercial Banks for Business Activities (BUKU) I 2015-2020. The data of this research is obtained from financial reports published by each bank in 2015 to 2020 period. This research uses panel data processed using EViews software version 9.0. The results show that NPL negatively and insignificantly affects CAR. ROA gives positive and insignificant impacts toward CAR, while ROE causes negative and insignificant effects on CAR. In addition, there is positive and significant impacts on CAR caused by LDR.

A computable general equilibrium model as a banking sector regulatory tool in South Africa

AbstractA computable general equilibrium (CGE) model is used as a regulatory tool for the banking sector in South Africa. The model is used to determine the effects of regulatory penalties, capital adequacy requirements (CAR) and the monetary policy on the economy. Our results indicate that there is a trade‐off between the default and the CAR regulation. For example, when reducing the default penalty, the banks' profits increase, whereas reducing the CAR violation penalty, banks' profits decrease. Changes to the default penalty have a stronger impact than changes in the CAR violation penalty (i.e. when both penalties are reduced, the banks' profits increase). Moreover, regulatory policies that are targeted at different banks produce asymmetric results, as well capitalised banks with richer portfolios swiftly readjust their balance sheet and transfer the default externality to the more constrained banks and/or the private sector agents.

Analysis of the Capital Structure of Commercial Banks

The article presents a regression analysis of banking determinants and their impact on the capital structure of banks for the period 2011–2019 on an extensive statistical base of the countries of India, Russia, China, the USA and banks in the Eurozone. The study proceeds and is based on the empirical results of the analysis of the structure of bank capital, carried out for individual countries up to the specified period. These results turned out to be quite contradictory regarding the significance of different determinants of the structure of bank capital. Understanding the influence of the determinants on the stability of the banking system, the article attempts to explain the differences for the period 2011–2019, when the countries' banking systems adopted the Basel 3 capital adequacy requirements. It is shown that 1) the capital structure of banks is influenced not only by banking determinants, but also by development conditions, regulatory institutions, the state of the economy, which is evidence of the need to analyze the problems of forming the capital structure of banks by countries, types of banks, etc.; 2) banking determinants between 2011 and 2019 explain the variation in bank capital structure to a significant extent and regulatory action is relevant for all countries. From the point of view of the peculiarities of the formation of the structure of bank capital and the role of the regulator in this case, directions of modification of relevant theories of capital structure are proposed.

Analisis Faktor Penentu Pembiayaan Bank Syariah Di Indonesia

This study aims to analyze the determinants of financing in Islamic banking in Indonesia. The independent variables in the study are Third Party Funds (DPK), Return on Assets (ROA), Financing to Deposit Ratio (FDR), Minimum Capital Adequacy Requirement (KPMM), Non-Performing Financing (NPF_Gross), Against Islamic Commercial Banks in Indonesia. . The population used in this study were all Indonesian Islamic banking for the 2010-2020 period, namely 14 banks. The sample of this research is using 8 Islamic banking. With the sampling method, namely purposive sampling. The results of this study are that the third-party funds (DPK) have a positive and significant effect on Islamic bank financing. Return on Asset (ROA) has a negative and significant effect on Islamic bank financing. Financing to Deposit Ratio (FDR) has a positive and significant effect on Islamic bank financing. Minimum Capital Adequacy Requirement (KPMM) has a positive and insignificant effect on Islamic bank financing. Non-performing financing (NPF_Gross) has a negative and significant effect on Islamic bank financing.

Analysis of the Health Level of Rural Banks Based on the Risk Base Bank Rating Method in Gianyar Regency

The health of a bank is in the interest of all related parties, including bank owners and managers, the public using bank services, and bank supervisors. Bank Indonesia assesses the soundness of banks using a method with a risk approach called the Risk Based Bank Rating (RBBR). This study aims to determine the soundness of Rural Banks (BPR) in Gianyar Regency in 2015-2020 using the RBBR method. This method consists of four assessment factors, namely risk profile, GCG, earnings and capital. The results of the study show that there are still several BPRs in Gianyar Regency that have the predicate of being unhealthy or violating the NPL, LDR and ROA ratios in accordance with the provisions of the law. The assessment of the Good Corporate Governance (GCG) factor in this study focused on the compliance function with the implementation of internal audit and external audit on financial statements implemented by banks. The internal audit function has been implemented by banks from 2015 to 2020. External audits were implemented by banks in 2019 and 2020. In 2019, 19 or 76 percent of 25 banks were audited by external auditors, and 6 banks or 24 percent were not audited by external auditors. The results of the Assessment of Capital Ratio with Minimum Capital Adequacy Ratio (KPMM), all BPRs with Very Healthy Predicate with KPMM Ratio greater than 12 percent. In 2019, 19 or 76 percent of 25 banks were audited by external auditors, and 6 banks or 24 percent were not audited by external auditors. The results of the Assessment of Capital Ratio with Minimum Capital Adequacy Ratio (KPMM), all BPRs with Very Healthy Predicate with KPMM Ratio greater than 12 percent. In 2019, 19 or 76 percent of 25 banks were audited by external auditors, and 6 banks or 24 percent were not audited by external auditors. The results of the Assessment of Capital Ratio with Minimum Capital Adequacy Requirement (KPMM), all BPR with Very Healthy Predicate with KPMM Ratio greater than 12 percent.

Sell or Hold? On the Value of Non Performing Loans and Mandatory Write-Off Rules

In this paper, we study the impact of mandatory write-off rules on a bank's reservation price of a non-performing loan (NPL). We develop a model of information asymmetry in NPL markets where agents are using risk neutral pricing. In contrast to existing literature, we assume that agents agree on the expected recovery rate of an NPL. We show that differences in the estimation accuracy of the drift of the underlying recovery rate process lead to valuation differences. In the model, the differences in the precision when estimating the drift of the underlying lead to differences in the aggregated variance of the payoff distribution. Since an NPL's payoff function is nonlinear this results in different NPL valuations depending on this precision parameter. This, in combination with capital adequacy requirements banks need to maintain and funding costs they face leads to the result that a bank's reservation price of an NPL might be below its own valuation.

Cross-border banking and foreign branch regulation in Europe

PurposeThis paper aims to examine the relevance of cross-border activity in the European banking sector, evaluating the role of differences in regulation to explain the level of interest in entering foreign markets.Design/methodology/approachThe sample considers all banks in the European Union (EU 28) existing at year-end 2017, and information about the ultimate owners’ nationality to classify local and foreign banks is collected. The analysis provides a mapping of regulatory restrictions for foreign banks and evaluates how they impact the role of foreign players in the deposit and lending markets.FindingsResults show that the lower are the capital adequacy requirements, the higher are the amounts of loans and deposits offered by non-European Economic Area banks and, additionally, the higher the probability of having a foreign bank operating in the country.Originality/valueThis paper provides new evidence on regulatory arbitrage opportunities in the EU and outlines differences among EU countries not previously studied.

Governor Ciampi and the “Ambrosiano Case”: International Banking Supervision and Monetary Policy

Following bank failures in 1974, notably in Germany (Bankhaus Herstatt of Cologne on June 16) and the US (Franklin National Bank of New York on October 8), the Central Bank Governors of the G10 countries decided to set up a Committee at the BIS in Basel to improve quality and enhance the effectiveness of banking supervision. The Eurodollar market and the rise of offshore financial centers had concurred to create an increasingly interlinked web of international banking transactions. The system of national supervision of domestic banking system had to be completed by incisive and coordinated action at international level, also to cope with the vulnerability to frauds and interactions with organized crime. The Basel Committee issued in December 1975 the Concordat, which provided a framework for international banking supervision and made a distinction between solvency and liquidity. It was within this emerging frame of reference that the Bank of Italy and the G10 Governors dealt with the crisis of the Banco Ambrosiano Group: the crisis had started in 1977 and was concluded with the formal liquidation on August 6 1982. The measures taken by Governor Ciampi and Treasury Minister Andreatta, the dialectical interactions with the Basel Committee, the G10 Governors (banking supervision and monetary policy) and the IOR in the Vatican City are analized and discussed in this article. In preparing the paper the author could benefit from the extremely competent support of the Historical Archives of the Bank of Italy and the access to documents only recently accessible for public consultation. As is shown, the action undertaken by Governor Ciampi and by the Bank of Italy in the Ambrosiano case contributed to the evolution of banking supervision as regards both the revision of the Concordat and, thereafter, the development of a system of mandatory risk-weighted capital ratios. A parallel lasting lesson is that capital adequacy requirements must be complemented by targeted effective supervisory guidance and oversight of corporate governance for banking firms to prevent, insofar as possible, inappropriate and illegal practices, while ensuring accountability of shareholders and top managers for their wrongdoings.

Price mediated contagion through capital ratio requirements with VWAP liquidation prices

We develop a framework for price-mediated contagion in financial systems where banks are forced to liquidate assets to satisfy a risk-weight based capital adequacy requirement. In constructing this modeling framework, we introduce a two-tier pricing structure: the volume weighted average price that is obtained by any bank liquidating assets and the terminal mark-to-market price used to account for all assets held at the end of the clearing process. We consider the case of multiple illiquid assets and develop conditions for the existence and uniqueness of clearing prices. We provide a closed-form representation for the sensitivity of these clearing prices to the system parameters, and use this result to quantify: (1) the cost of regulation, in stress scenarios, faced by the system as a whole and the individual banks, and (2) the value of providing bailouts to consider when such notions are financially advisable. Numerical case studies are provided to study the application of this model to data.

Impact of Basel III on the discretion and timeliness of Banks’ loan loss provisions

The Basel III Accord tightens capital adequacy requirements for banks by increasing the minimum Tier 1 regulatory capital threshold from 4 to 6 percent. It also emphasizes the need to improve timeliness of loan loss provisions. Using a sample of European banks, we examine the impact of this regulation on banks’ discretionary loan loss provisioning behavior. Underscoring banks’ increased incentives to report higher capital ratios, we observe a post-Basel III increase in banks’ use of discretionary loan loss provisions (DLLPs) for capital management purposes and a corresponding reduction in the use of these provisions for income smoothing purposes. Moreover, we find that the timeliness of loan loss provisions has improved following Basel III. We also find that the post-Basel III increase in capital management behavior is greater for banks that do not face conflicting incentives when using DLLPs to improve Tier 1 versus total capital ratio. In contrast, the improvement in loan loss provisioning timeliness is greater for banks that are less likely to engage in capital management due to these conflicting incentives. Our findings suggest that Basel III has significantly altered banks’ discretionary loan loss provisioning behavior.

Out-of-Sample Predictability of Economic Efficiency Measures of U.S. Banks: Evidence of Capital Adequacy Requirements

Abstract This paper contributes to the sparse debate on the effect of capital adequacy requirements on banks’ economic efficiency measures. Precisely, we evaluate the out-of-sample predictability of capital adequacy requirements on banks’ economic efficiency measures using Support Vector Regression (SVR) model with Linear, Polynomial and Radial Basis Function kernels and ordinary least squares (OLS) model. This analysis is important because a prediction of economic efficiency measures allows for an untangle view of bank’s progress that is useful for management as it gains a high degree of transparency in the evaluation of future events. Our framework adapts optimization of h-block cross-validation to account for serial correlation of economic variables to produce robust sets of tuning parameters for SVR model. Using a total of 10,380 December quarterly observations of U.S. Commercial and Domestic banks spanning from 2008 through 2019, empirical results show that SVR model provides better benchmarking insights in the evaluation of economic efficiency measures compared to the OLS model. Furthermore, in contrast to previous approaches identifying a single “best” model among competing models, the results of Model Confidence Test suggests that the out-of-sample forecasting confidently identifies superior predictive accuracy of SVR model-based forecasts over OLS model.