Capital Regulation Research Articles

National Varieties Still Matter: A Comparative Analysis of Consumer Credit Data Regimes in the United States, Sweden, Israel, and France

Before asking why countries vary, we should ask how they differ. Stressing variations in capitalism models, this article explores how regulatory regimes are related to underlying national institutions and politics. Using a stepwise comparative analysis of consumer credit data regimes in four countries, it underscores variation in two regulatory dimensions: the business restrictions between two clusters, the United States and Sweden vs. France and Israel; and the consumer empowerment within these clusters. The article concludes that grasping the regulatory state’s multidimensional character improves understanding of the regulatory process and underlines the continuity of national capitalist models in the era of regulatory capitalism.

Can the transition from Basel II to III change the monetary policy impact on the Iranian economy and banking system?

Using a dynamic stochastic general equilibrium (DSGE) model, we analyzed the impact of the Basel II and III capital requirements regulations on the effects of monetary policy shocks on the behavior of the macroeconomy and the Iranian banking system. According to the structural shocks, four observable variables including output gap, bank capital adequacy, inflation and money base growth rate during the period from 2004Q1 to 2020Q4 were included in the Bayesian estimation process along with some other predetermined parameters. Finally, the impulse-response functions of the model were interpreted in two scenarios Basel II or III to the capital adequacy ratio. The results suggest that if banks operate under the Basel II capital regulations, the central bank’s use of money supply may lead to low growth in the economy in the short-run, but in the medium- and long-run, the negative effects will be much larger. However, with the introduction of Basel III regulations for banking business, the output fluctuations will be reduced by the expansion of money supply. The results also show that a shock to the money supply leads to a sharp increase in inflation, and it is noteworthy that the introduction of Basel II or III does not affect the nature of the inflation response to monetary policy. Finally, we found that in both scenarios of the introduction of Basel II and III due to a monetary policy shock, bank profitability falls sharply in the short-run. However, with the adjustments that the bank makes to interest rates, it quickly returns to profitability.

Introducing Two Parsimonious Standard Power Mixture Models for Bimodal Proportional Data with Application to Loss Given Default

The need to model proportional data is common in a range of disciplines however, due to its bimodal nature, U- or J-shaped data present a particular challenge. In this study, two parsimonious mixture models are proposed to accurately characterise this proportional U- and J-shaped data. The proposed models are applied to loss given default data, an application area where specific importance is attached to the accuracy with which the mean is estimated, due to its linear relationship with a bank’s regulatory capital. In addition to using standard information criteria, the degree to which bias reduction in the estimation of the distributional mean can be achieved is used as a measure of model performance. The proposed models outperform the benchmark model with reference to the information criteria and yield a reduction in the distance between the empirical and distributional means. Given the special characteristics of the dataset, where a high proportion of observations are close to zero, a methodology for choosing a rounding threshold in an objective manner is developed as part of the data preparation stage. It is shown how the application of this rounding threshold can reduce bias in moment estimation regardless of the model choice.

Fundamental Factors and Capital Behavior of Banking in Indonesia

Capital has an important role in banking operations, in addition to indicating the fulfillment of capital regulations also serves to anticipate future risks. Studies of ROA-mediated capital buffers are still rare. This study aims to investigate the role of return on assets as mediation on the influence of loans to total assets (LOTA) and non performing loans (NPL) on capital buffers. This study is conducted by using path analysis research conducted on commercial banks owned by the government with an observation period from 2015 to 2020. The existence of interference, especially on the funding side, is one of the characteristics of the company's bank. The results showed that lota negatively affects ROA and capital buffer while NPL negatively affects ROA and positively affects capital buffer. In roa mediation testing is able to mediate the influence of NPL on capital buffers but is not able to mediate LOTA's engaruh against capital buffers.

IV estimation of spatial dynamic panels with interactive effects: large sample theory and an application on bank attitude towards risk

Summary This paper develops a new instrumental variables estimator for spatial, dynamic panels with interactive effects under large N and T asymptotics. For this class of models, most approaches available in the literature are based on quasi-maximum likelihood estimation. The approach put forward here is appealing from both a theoretical and a practical point of view for a number of reasons. First, it is linear in the parameters of interest and computationally inexpensive. Second, the IV estimator is free from asymptotic bias. Third, the approach can accommodate endogenous regressors as long as external instruments are available. The IV estimator is consistent and asymptotically normal as $N,T\rightarrow \infty$, such that $N/T \rightarrow c$, where $0\lt c\lt \infty$. We study the determinants of risk attitude of banking institutions. The results show that the capital regulation introduced by the Dodd–Frank Act has succeeded in influencing banks’ behaviour.

Bank regulation, supervision and lending: empirical evidence from selected Sub-Saharan African countries

ABSTRACT This study investigates the impact of bank regulation and supervision on bank credit in 23 Sub-Saharan African (SSA) countries and their low- and middle-income groups from 1995 to 2017. The long-run results indicated that stringent entry barriers and supervisory power reduced lending, but supervisory power mitigated the negative effect of entry barriers. Furthermore, positive shocks to entry barriers impacted negatively on bank credit, while negative shocks to capital requirements had an adverse impact on lending. In the short run, positive shocks to entry barriers, activity restrictions and capital regulations led to increases in bank credit, particularly in low-income SSA economies.

Impact of income diversification on bank stability: a cross-country analysis

PurposeThe impact of diversification on bank stability and risk remains an ongoing topic of discussion with inconclusive results. Hence, this study investigated the implications of income diversification on bank stability within African markets.Design/methodology/approachThe study utilised longitudinal financial data on 45 countries from 2000 to 2017 and employed static and dynamic panel model estimation.FindingsThe results of the study suggest income diversification technique could improve financial stability throughout typical and crisis periods which validate portfolio management theory. The study also confirms the “too big to fail” hypothesis, extensive diversifying over an optimal range negatively impacts stability. Banks with a high level of liquidity, a higher operating efficiency and a larger deposit ratio become more resilient. Banking capital regulations found to be the appropriate monitoring instrument for lowering risks and maintaining stability. However, profitability was found to have a positive effect on bank risk-taking. The finding also suggests that political institutions have substantial, direct implications that are positively related to bank fragility. Macroeconomic factors such as gross domestic product (GDP) growth and inflation also influenced bank stability.Practical implicationsThis study has important implications for bankers, regulators and academicians concerned about the effect of diversification on a bank’s risk-taking or stability in developing economies.Originality/valueTo the best of the author’s knowledge, this is the first study on Africa to analyse the quadratic influence of income diversification and the effects of political institutions on the level of bank stability.

Market competition, capital regulation and cost of financial intermediation: an empirical study on the banking sector of Bangladesh

PurposeThis study aims to examine the impact of market competition, and capital regulation on the cost of financial intermediation of banks of the Bangladesh banking industry.Design/methodology/approachThis study has used a balanced panel dataset comprised of 340 firm-year observations for 34 commercial banks in the Bangladesh banking industry from 2011 to 2020. The Prais Winsten panel estimator has been used to assess the impact of market competition and capital regulation on the cost of financial intermediation of banks.FindingsBased on the regression results, this study has documented that greater market competition results in a lower cost of financial intermediation for banks. Similarly, an increase in the regulatory capital of banks increases the cost of financial intermediation of banks. The main findings of this study are found robust by using alternative proxies for the cost of financial intermediation, market competition and capital regulation. The regression results also suggest that private commercial banks tend to have a higher cost of financial intermediation than state-owned commercial banks.Research limitations/implicationsThe regulatory reforms should aim to foster sustainable and optimal market competition for the Bangladesh banking industry to regulate the market power of banks to reduce the cost of financial intermediation. The regulatory authority of Bangladesh should find the optimal policy measures for implementing the capital regulation in the banking industry which would reduce the cost of financial intermediation margin of banks.Originality/valueUnlike previous studies which have used structural market competition measures, this study has used non-structural market competition measures to assess the relationship between market competition and cost of financial intermediation in the Bangladesh banking industry.

Market discipline and bank risk through new regulations: evidence from Asia–Pacific

PurposeThe purpose of this study is to show the presence of market discipline and provide an explanation for bank risk nondisclosure behavior, specifically market risk (MR), credit risk (CR), operational risk (OR) and counterparty credit risk (CCR). The response of market discipline when banks comply with Basel III capital and liquidity restrictions is also investigated in this study.Design/methodology/approachThe study used the Lasso regression method to give accurate results with the lowest error when using small observational data with a large number of features.FindingsFirst, theoretically, the study points to the presence of market discipline and its sensitivity to the risks disclosed by the bank, especially when applying capital regulations under Basel III. In addition, the study also shows differences between the developed and emerging countries in the sensitivity of market discipline to factors when considering banking regulations. Finally, an interesting result that the study shows is that the higher the index of economic freedom, the weaker the market discipline is, especially for emerging countries.Practical implicationsThe study’s findings have several important implications: (1) help regulators devise policies to manage banks' risk and meet liquidity and capital requirements according to the Basel III framework. The effectiveness of market discipline is reduced, and banking regulators need to compensate by strengthening their supervisory functions. (2) Showed the reasons why banks ignore the disclosure of bank risks according to the provisions of the third pillar of the Basel III framework. Because when following the Basel III framework, depositors demand higher interest rates or increase market discipline towards riskier banks.Originality/valueThis study is the first attempt to assess market discipline under the new capital and liquidity regulations using the Lasso regression model as suggested by Tibshirani (1996, 2011), Hastie et al. (2009, 2015). This is also the first study to look at the impact of four different forms of risk on market discipline (as required by the Basel regulatory framework to improve disclosure).

Bank Capital, Risk and Profitability: A Comparative Study of Europe and Mena Countries

The purpose of this paper is to investigate the role of capital regulations in relation to bank risk and profitability across two different regions i.e. Europe and the Middle East and North Africa (MENA). The sample for this study includes annual data of 502 banks from European and MENA banking sectors for the period 2010-2019. The study employs OLS regression to ascertain whether Basel and non-Basel based capital ratios affect bank risk and profitability across different economic regions. The study also used Generalized Method of Moments and Limited Information Maximum Likelihood to remove the issue of possible endogeneity problems. The results show bank capital ratios comprises of risk-weighted assets are more effective in minimizing credit default risk and increasing profitability of banks in the European and MENA regions. Moreover, findings imply that complying with Basel capital guidelines do not penalize bank activities in one region compared to another. Overall results imply that bank regulators in both regions should make policies in compliance with Basel (III) capital guidelines to achieve financial stability.

Variation in the competition − Efficiency nexus: Evidence from emerging markets

This study documents a large cross-country variation in the relationship between bank competition and efficiency in the context of 24 emerging markets. On average, higher market power is associated with greater bank efficiency, but an increase in market power has a more substantial impact in countries with stricter capital regulation, better market discipline, greater official disciplinary power, more developed financial markets, lower levels of bank branch penetration, and lower credit information availability.

Can machine learning models save capital for banks? Evidence from a Spanish credit portfolio

We study the impact of machine learning (ML) models for credit default prediction in the calculation of regulatory capital by financial institutions. We do so by using a unique and anonymized database from a major Spanish bank. We first compare the statistical performance of five models based on supervised learning like Logistic Lasso, Trees (CART), Random Forest, XGBoost and Deep Learning, with a well-known model like Logit. We measure the statistical performance through different metrics, and for different sample sizes and features available. We find that ML models outperform, even when relatively low amount of data is used. We then translate this statistical performance into economic impact by estimating the savings in capital when using an advanced ML model instead of a simpler one to compute the risk-weighted assets following the Internal Ratings Based (IRB) approach. Our benchmark results show that implementing XGBoost instead of Logistic Lasso could yield savings from 12.4% to 17% in terms of regulatory capital requirements.

Nonlinear effects of bank regulation stringency on bank lending in selected sub-Saharan African countries

PurposeThis paper aims to investigate the nonlinear effects of bank regulation stringency on bank lending in 23 sub-Saharan African (SSA) countries over the period 1997–2017.Design/methodology/approachThis study employs the dynamic panel threshold regression (PTR) model, which addresses endogeneity and heterogeneity problems within a nonlinear framework. It also uses indices of entry barriers, mixing of banking and commerce restrictions, activity restrictions and capital regulatory requirements from the updated databases of the World Bank's Bank Regulation and Supervision Surveys as measures of bank regulation.FindingsThe linearity test results support the existence of nonlinear effects in the relationship between bank lending and entry barriers or capital regulations in the selected SSA economies. The dynamic PTR estimation results reveal that bank lending responds positively when the stringency of entry barriers is below the threshold of 62.8%. However, once the stringency of entry barriers exceeds that threshold level, bank credit reacts negatively and significantly. By contrast, changes in capital regulation stringency do not affect bank lending, either below or above the obtained threshold value of 76.5%.Practical implicationsThese results can help policymakers design bank regulatory measures that will promote the resilience and safety of the banking system but at the same time not bring unintended effects to bank lending.Originality/valueTo the best of the authors’ knowledge, this is the first study to examine the nonlinear effects of bank regulatory measures on bank lending using the dynamic PTR model and SSA context.

New Perspectives on Insurance

Abstract This special issue originates from a dual submission conference with the NBER Insurance Working Group and the Corporate Finance Program in 2020. It brings a broader perspective on important frictions in insurance markets, including trust between insurers and policyholders, conflicts of interest among brokers, suboptimal policyholder behavior, and risk-based capital regulation. Several developments in the economy and the academic literature have provided an impetus for new perspectives, including the growth of savings products with minimum return guarantees, the global financial crisis, and intermediary asset pricing. We conclude with an overview of research questions that are promising for further exploration.

Financial Intermediation, Capital Accumulation, and Crisis Recovery

Abstract We integrate bank and bond financing into a two-sector neoclassical growth model and identify an automatic stabilization effect due to endogenous bank leverage adjustment. We show that although bank leverage amplifies shocks, the increase of leverage due to a decline in bank equity partially offsets the post crisis decline of bank lending and accelerates economic recovery by reducing the persistence of the bank lending channel. In this case, endogenous leverage adjustment is an automatic stabilizer. Regulatory state-independent capital limits and wage rigidities impair the re-allocation of capital between sectors and weaken this automatic stabilization. A quantitative analysis of the US during the Great Recession shows that the magnitude of automatic stabilization can be significant and informs about potentially high costs of strict capital regulation or wage rigidities during banking crises.

Improved credit default prediction using machine learning and its impact on risk-weighted assets of banks

The use of risk models, especially credit risk models, has been a standard for banks for many years. Banks use models not only for business decision purposes but also for regulatory purposes when comparing their risk with the available regulatory capital. Furthermore, banks need to efficiently allocate their capital in the current competitive and regulatory environments. As part of this process, they develop models to predict the probability of default (PD), which are further used to calculate risk-weighted assets (RWA). This paper gives an overview of how banks calculate RWA for credit risk. We compare the performance of traditional PD models based on logistic regression with a machine learning (ML) algorithm based on gradient boosting. This shows that an improvement in PD model performance by using ML algorithms can also lead to a decrease of RWA, therefore releasing additional capital for the banks. We developed and calibrated PD models based on logistic regression and light gradient boosting machine (GBM) approaches and compared them in terms of discriminatory power and the impact on RWA to prove this statement. This paper shows that the use of ML leads in our case study to an improvement in the model’s discriminatory power of 5 per cent in terms of Gini and releasing RWA of approximately 6.5 per cent.

APAKAH BANK ISLAM MALAYSIA MENGELOLA PENGHASILAN DENGAN PROFIT EQUALIZATION RESERVE?

Income management is not an important factor for PER, because the EBTZP variable is not significant. Future studies need to examine how PER affects capital regulation. The findings of this study indicate that Islamic Banks use PER and IRR to stabilize profits. Although there is empirical evidence on PER behavior and IRR allowance by Islamic Bank institutions, evidence from other financial institutions is still scarce. Based on this research, in the case of Malaysia, there are other institutions that offer Islamic financial products and services, namely developing financial institutions such as Agro Bank, SME Bank, National Savings Bank. These results indicate that Bank Malaysia does not equalize income over time using PER, and in this study it is shown that income management is not an important factor in PER.

Overlaps between minimum requirements and capital buffers: the usability of the combined buffer requirement for Italian banks

The current EU capital regulation requires that banks comply with two main frameworks at the same time: one for prudential purposes, the other for resolution purposes. The first one includes both a risk-weighted requirement (RW) and a leverage ratio requirement (LR). Similarly, the resolution framework, which ensures that banks have enough loss-absorbing and recapitalization capacity through a Minimum Requirement of Eligible Liabilities (MREL), is based on two ratios that are to be met in parallel: the MREL as a percentage of risk weighted assets (MREL-RW) and the MREL as a percentage of the total exposure measure used for the purpose of the leverage ratio (MREL-LR). According to the EU regulation, the CBR is only required on top of the two risk-weighted requirements (RW and MREL-RW).

Pro-Cyclicality of Provisions for Loan Losses

The crux of bank accounting is how to measure and disclose ex ante credit risk, as loan yields and cost of funds are determined by managerial effectiveness and the financial market. This paper examines how the practice of setting up provisions for loan losses by bank managers had changed to preserve regulatory capitals around the 2008 financial crisis. This paper examines the empirical relationship between ex ante credit loss, which is proxied by loan losses provisions, and realized credit loss, which is measured by net charge-off. The empirical relations are examined before, during, and after the 2008 financial crisis to find the patterns of prediction errors of the incurred loss model. This paper obtains evidence that the empirical relation between non-performing assets and provisions for loan losses weakened at the time of a financial crisis. The relations of net charge-offs and allowance for loan losses on provisions for loan losses amplified during a financial crisis by accounting design. After the financial crisis is over, the empirical relation between non-performing assets and provisions for loan losses does not return back to the pre-crisis relation, but to a different, new post-crisis relation. This paper obtains evidence that financially stable banks in terms of the tier 1 capital ratio, return on assets, market-to-book ratio, or dividend payout ratio tend to adjust provisions for loan losses in a larger scale in response to a financial crisis than less stable banks.

Effects of the ECL Model on Regulatory Capital in European Banks

The paper’s purpose was to assess whether the effects on the regulatory capital of the ECL model in European banks differs among those that adopted IRB or standardized approaches to credit risk management. The empirical tests revealed that there was a significant reduction in the level of capita buffers of European banks when the IFRS 9 was first adopted, and that this reduction was more pronounced among banks using a standardized approach to credit risk than for those that relied on an IRB approach. Further testing confirmed the premise that there was an underestimation of capital requirements in the period prior to the adoption of the ECL. The study fills a gap in literature, by evaluating the difference in the impact of adopting the ECL model on the banking system, as a function of the credit risk management approach for capital purposes. The assessment of what happened in the European banking system can be used as a guidance to other jurisdictions still in transition to the ECL model.