Stricter Capital Requirements Research Articles

Impact of Financial Regulations on Bank Profitability in Uganda

Purpose: The aim of the study was to assess the impact of financial regulations on bank profitability in Uganda. Methodology: This study adopted a desk methodology. A desk study research design is commonly known as secondary data collection. This is basically collecting data from existing resources preferably because of its low cost advantage as compared to a field research. Our current study looked into already published studies and reports as the data was easily accessed through online journals and libraries. Findings: Financial regulations significantly influence bank profitability, primarily by affecting operational costs, risk management practices, and lending activities. Stricter capital requirements, such as those imposed by Basel III, generally enhance financial stability but may reduce profitability by limiting leverage and increasing the cost of compliance. Regulatory measures aimed at consumer protection and transparency, while beneficial for market integrity, can also impose additional administrative burdens and costs on banks. Conversely, deregulation periods often see increased profitability due to relaxed constraints on lending and investment activities. However, this can come at the expense of higher risk exposure and potential financial instability. Overall, the balance between regulatory stringency and bank profitability hinges on the specific regulations in place and the banks' ability to adapt and innovate within those frameworks. Implications to Theory, Practice and Policy: Agency theory, capital structure theory and information asymmetry theory may be used to anchor future studies on assessing the impact of financial regulations on bank profitability in Uganda. Practitioners should advocate for risk-based regulation that tailors regulatory requirements to banks' risk profiles and systemic importance. Policymakers should prioritize efforts to harmonize financial regulations across jurisdictions, especially in global banking hubs.

The Impact of Capital Regulations on Bank Margins of ASEAN Banking Sector

Basel Committee on banking supervision (BCBS) has issued Basel which requires the banks to comply with the minimum capital requirement after the crisis. Nevertheless, whether the requirement imposes impact the banking sector which comprises a dual banking system, in a positive manner is still questionable. Given the higher capital costs from the strict capital requirements, banks are being forced to raise bank margins. This study investigates the effect of capital regulations on conventional and Islamic banks’ margins covering the ASEAN banking system from 2009 to 2017. The empirical analysis uses dynamic panel data frameworks to reveal several factors affecting bank margins. Overall, the results suggest that the total regulatory capital ratio helps reduce the margins of conventional banks but does not influence the margins of Islamic banks. As for the Tier-1 capital ratio, the variable increases the Islamic bank margins but does not significantly affect conventional bank margins. Based on the analysis results, regulators of conventional banks need to impose capital requirements as suggested by Basel III to reduce bank margins. Meanwhile, as for Islamic banks, the bank margins can be reduced if regulators can introduce a separate set of requirements tailored explicitly for Islamic banks.

Banking on the Lawyers

This Article is the first to analyze an unexplored but critical change in how modern banks are governed: the rise of lawyers as bank directors. That rise has been precipitous, raising the question of why lawyer-directors now sit on most bank boards. Using novel empirical evidence, we show that lawyer-directors at banks are associated with efficient changes in risk management and significant increases in bank value. In particular, banks with lawyer-directors assume more risk in ordinary (non-crisis) circumstances and less risk when a crisis arises, in each case in a way that makes banks more valuable. Lawyer-directors do this by drawing on advocacy skills to critically analyze opposing points of view, an essential quality in managing the risks banks face today. They are also more likely to make complex information, sourced from multiple experts, more accessible to a bank’s board as part of its decision-making process. Finally, lawyer-directors are skilled at assessing litigation and regulatory risks, which have grown significantly in recent years. Risk management failures were a primary cause of the 2008 financial crisis, prompting two principal regulatory responses: stricter capital requirements and enhanced governance. Their effectiveness remains hotly debated. Our findings have two important implications. First, we challenge the notion that stricter regulation is sufficient for efficient risk management. Rather, to manage a bank, directors must have the skills to think critically about risk. Second, we underscore the value of director expertise, showing that more is needed than simply the director’s independence now mandated by law.

Market Discipline and Systemic Risk

We analyze a general equilibrium model in which financial institutions generate endogenous systemic risk. Banks optimally select correlated investments and thereby expose themselves to fire-sale risk so as to sharpen their incentives. Systemic risk is therefore a natural consequence of banks’ fundamental role as delegated monitors. Our model sheds light on recent and historical trends in measured systemic risk. Technological innovations and government-directed lending can cause surges in systemic risk. Strict capital requirements and well-designed government-asset purchase programs can combat systemic risk. This paper was accepted by Gustavo Manso, finance.

Systemic banks, capital composition, and CoCo bonds issuance: The effects on bank risk

AbstractThis paper shows that systemic banks are prone to increase their regulatory capital ratio through a decline in risk‐weighted assets density and an intense use of lower level capital. The market access of systemic banks and the fact that they were singled out for higher capital requirements seem to have biased them towards lower level capital, consistent with the theory that asymmetric information drives capital decisions. These effects are particularly strong for institutions that had a rather low level of capitalization at the start of the period and for those that exhibited a strong use of additional Tier I capital before the regulatory changes. Strict capital composition requirements for firms with lower buffers would be an improvement.

Systemic Banks, Capital Composition and Coco Issuance: The Effects on Bank Risk

This paper shows that systemic banks are prone to increase their capital ratio through a decline in risk-weighted assets density and an intense use of lower level capital. The market access of systemic firms, and the fact that they were singled out for higher capital requirements. seem to have biased them towards lower level capital, consistent with the theory that asymmetric information drives capital decisions. These effects are particularly strong for firms that were rather under-capitalized at the start of the period. More transparency in the pricing of lower capital level would reduce the incentives to use it, while strict capital composition requirements for firms with lower buffers would be an improvement.

Governance of the Single Resolution Mechanism

In the early morning of 20 March 2014, after lengthy and heavy negotiations, an important step towards completion of the European Banking Union was taken. In a so-called ‘trilogue’ between the European Commission, the European Parliament and the Council, political agreement was reached on the uniform and centralized resolution of ailing banks within the Eurozone, the so-called Single Resolution Mechanism (SRM). The SRM’s aim is to ensure an effective European reaction when a bank - despite stricter capital requirements and stricter supervision - gets into serious trouble. The basic principle is that no longer the taxpayer, but the private sector will bear the costs of bank resolutions. This article analyzes the governance or decision-making structure of the SRM. In this article, ‘governance’ or ‘decision-making’ is understood in a broad sense. It does not only refer to individual decision-making, but also includes decision-making of a more general nature, such as the adoption of delegated or implementing acts. In particular, the SRM’s governance structure with respect to the following two key topics will be discussed: (1) financing of the Single Bank Resolution Fund (the Fund); (2) adoption of a resolution scheme.

Deutsche Bank and the Road to Basel Iii

This public-sourced case was named the best finance case of 2013 in the 24th annual awards and competition sponsored by The Case Centre. It was designed for and works well in the latter portion of a GEMBA Financial Management and Policies course and in the early stage of a second-year MBA elective Financial Institutions and Markets course. The case is set in mid-2012 as the new co-CEOs of Deutsche Bank are about to speak in an analyst call. Students are the decision makers and have the opportunity to evaluate the various factors affecting a bank's situation in a changing global industry, such as leverage and credit quality, as well as to discuss the implications on Deutsche Bank and the banking sector more broadly of Basel III, the global regulatory reform. The students also have the opportunity to conduct a valuation of the bank. Investors were anxious to know whether the new co-CEOs would discuss the strategy of how Deutsche Bank planned to meet the new regulatory requirements, what effect Basel III would have on the company's profitability, and what lines of business it would focus on going forward in a new banking environment. They also wanted to know more about the benefits of the 2010 majority stake investment in Postbank, a German commercial bank. In class, this discussion also allows for a broader examination of the universal bank model and the role of banks within society. Excerpt UVA-F-1695 Rev. Jan. 28, 2019 Deutsche Bank and the Road to Basel III On July 31, 2012, Deutsche Bank Group (Deutsche Bank) reported its 2nd quarter 2012 financial results. What made this earnings report different from the company's past earnings announcements was that it marked the first time after former CEO Joseph Ackermann stepped down that co-CEOs Jurgen Fitschen and Anshu Jain would publicly address investment analysts and shareholders on Deutsche Bank's quarterly conference call since assuming their roles on June 1, 2012. The biggest question on the minds of analysts and investors was whether or not Deutsche Bank would be able to meet the capital requirements imposed under a revised global banking regulatory framework—Basel III. In response to the global financial crisis, the Basel Committee on Bank Supervision, consisting of senior representatives of the G20 central banks, began formulating the new framework in an effort to raise “the quality, consistency, and transparency of the capital base” of financial institutions worldwide. Although approved in December 2010, the new requirements would not take effect immediately. Rather, the various requirements would be phased in gradually, beginning in 2013 and becoming fully implemented by January 1, 2019. For banks, Basel III meant clearing a series of regulatory hurdles starting in 2013 that would fundamentally change the banking industry landscape. Investors were concerned that Deutsche Bank would need to raise fresh equity capital to meet the requirements, thereby diluting the equity value of existing shares. In addition, profitability in the banking sector had been in steady decline since the global financial crisis of 2008, and investors worried that stricter capital requirements would further reduce profitability at Deutsche Bank going forward. And the sovereign debt issues plaguing many European Union countries added more insecurity. . . .

Banks' Adjustment to Basel III Reform: A Bank-Level Perspective for Emerging Europe

The paper seeks to identify strategies of commercial banks in response to higher capital requirements of Basel III reform and its phase-in. It focuses on a sample of nine EU emerging market countries and picks up 5 largest banks in each country assessing their response. The paper finds that all banking sectors raised CAR ratios mainly through retained earnings. In countries where the banking sector struggled with profitability, banks have resorted to issuance of new equity or shrunk the size of their balance sheets to meet the higher capital-adequacy requirements. Worries echoed at the early stage of Basel III compilation, namely that commercial banks would shrink their balance sheet by reducing their lending to meet stricter capital requirements, did materialize only in banks struggling with profitability.

Higher Bank Capital Requirements and Mortgage Pricing: Evidence from the Counter-Cyclical Capital Buffer

How has the CCB affected mortgage pricing after Switzerland became the first country to activate this Basel III macroprudential tool? By analyzing a database with several offers per mortgage request, we construct a picture of mortgage supply and demand. We find, first, that the CCB changes the composition of mortgage supply, as relatively capital-constrained and mortgage-specialized banks raise prices more than their competitors do. Second, risk-weighting schemes linked to borrower risk do not amplify the CCB's effect. To conclude, changes in the supply composition suggest that the CCB has achieved its intended effect in shifting mortgages from less resilient to more resilient banks, but stricter capital requirements do not appear to have discouraged less resilient banks from risky mortgage lending.

Do Strict Capital Requirements Raise the Cost of Capital? Bank Regulation, Capital Structure, and the Low-Risk Anomaly

Traditional capital structure theory predicts that reducing banks' leverage reduces the risk and cost of equity but does not change the weighted average cost of capital, and thus the rates for borrowers. We confirm that the equity of better-capitalized banks has lower beta and idiosyncratic risk. However, over the last 40 years, lower risk banks have not had lower costs of equity (lower stock returns), consistent with a stock market anomaly previously documented in other samples. A calibration suggests that a binding ten percentage point increase in Tier 1 capital to risk-weighted assets could double banks' risk premia over Treasury bills.

A model of the interactions between asset prices bubble bursts and twin crises

This study develops a model to analyze the Interactions between twin crises—the banking crisis and the currency crisis—and their coincidence with the asset prices bubble bursts. Results show that the origin of both crises comes from agents worrying about the upcoming asset prices bubble bursts when bad economic fundamentals are announced. There are multiple equilibria crises in both two systems. Twin crises are caused by deteriorated fundamentals and fundamental-driven self-fulfilling prophecy. Our model offers some policy implications. First, it is unable to prevent twin crises by suspending deposit convertibility, full deposit insurance and financial dollarization. Second, suspension of currency convertibility can prevent a currency crisis, but not a banking crisis. However, the effect of lender of last resort is ambiguous. Finally, strict risk supervision and minimum capital requirements each can curtail twin crises.

Basel III: Redesigned regulatory framework for banks

The global financial crisis has confirmed the global regulatory mechanism weakness in the prevention of the causes and consequences in stress situations. As an expression of inadequacy, Basel Committee designed Basel III standard as a new regulatory framework for banks. Its implementation involves the compliance of strict capital requirements, liquidity standards and leverage. Researches about the effects of Basel III standards indicate that a shorter time horizon, these are the consequences for economic growth is greater. For the four-year implementation period, the increase in capital requirements for the 1% would result in a reduction in global GDP by 0.1%, while the largest drop in GDP would be recorded after 18th quarter and amounted to 0.19%. Also, during the implementation horizon cross-country spillover effect will occur that would be stronger in developing countries relative to developed countries and amounted to 0.03%. Based on the above, pure effect of increasing capital requirements on the reduction of world GDP is estimated to 0.016%.

Procyclical Effects of the Banking System During the Financial and Economic Crisis 2007-2009: The Case of Europe

This paper examines the relationship between adverse shocks to the banking system and their effect on the general economy in Europe. This topic was brought to the spotlight during the 2007-2009 financial and economic crisis, when the relatively healthy, at that time, European economy was severely hit by the spread of the US sub-prime mortgage problems. This interbanking contagion may have been one of the main, if not the primary, reasons why the region entered into a recession during the period. If significant evidence can be found to support this theory, it will make the need for more regulations on the financial system and stricter capital requirements even more apparent. The research includes comprehensive literature survey on past and recent financial crises, procyclical banking practices and their impact on the economy. Then it goes on to developing a theoretical model of the transmission of negative economic shocks from the financial system to the rest of the economy. The theoretical model is empirically tested on a range of banking specific and macroeconomic variables. The results show that a loss of confidence in the financial system and banking losses are followed by a significant decrease in the new loans to non-financial companies and subsequent economic contraction. Moreover, countries with better capitalized banks experienced smaller declines during the crisis and in general Tier 1 capital is correlated positively with economic growth.

Bank Competition and Capital Regulation

We analyze the effects of capital regulation on bank stability in a model where banks compete for loans and deposits, and where they face both a portfolio and an optimal contracting problem. In our setup, stricter capital regulation increases the risk of individual loans and may also increase a bank's probability of default because it relaxes the competition for loans. Therefore, capital regulation and competition have similar effects on bank stability, but with reversed signs: Stricter capital requirements tend to destabilize the banking sector when higher competition stabilizes it.

Relaxing Liquidity Constraints for Start-Ups: A Welfare Analysis Over the Italian Revised Corporate Law

This paper analyzes the welfare effects of the recently revised Italian corporate law, that allows limited liability companies (so called societa a responsabilita limitata) to replace the fulfillment of strict capital requirements with the subscription of insurancecontracts that make capital available in case of default. We find that such insurance contracts are not convenient for insurers. However, if a benevolent planner is willing to subsidize insurers' expected losses, these contracts turn out to be welfare improving for a wide range of the relevantparameters. By calibrating the model with Italian data, we find that social welfare is maximized when the premium charged by the subsidized insurance companies is about 10% of total capitalrequirements; moreover, in this case the planner faces negligible expected losses.

Loan Monitoring, Competition, and Socially Optimal Bank Capital Regulations

INTRODUCTION It is widely believed that the Federal Deposit Insurance Corporation's (FDIC's) flat-rate deposit insurance premium structure encouraged excessively risky bank lending and thereby contributed to the spate of U.S. bank failures during the 1980s and early 1990s. Several reforms have already been introduced to curb this incentive for bank moral hazard behavior. For instance, the 1991 FDIC Improvement Act (FDICIA) mandates the imposition of risk-adjusted capital standards and deposit insurance premiums and early bank closure policies that would reduce the financial burden on the FDIC.(1) However, the fundamental problem in implementing any reform is that the regulator may be less informed than the bank about the quality of the bank's loan portfolio. Several authors have therefore analyzed the design of incentive-compatible regulations which would lead the bank to truthfully reveal its loan quality. But there is little consensus about the existence and nature of such regulations.(2) Furthermore, the regulator's problem is not over if incentive-compatible regulations can be designed. The regulator must next choose one scheme, from an array of incentive-compatible regulations, which will maximize social welfare. However, the welfare implications of regulatory design under asymmetric information have been relatively unexplored in the literature.(3) This article has two main objectives. First, it examines the existence of incentive-compatible regulations in a framework that explicitly incorporates two important features of banking activity: monitoring services provided by the bank to its clients, and potential collusion between the bank and the borrower (through side-payments) to extract a regulatory subsidy. Second, it analyzes the nature of socially optimal incentive-compatible regulations under full information and asymmetric information. A bank in our model performs two intermediation functions. First, the bank provides liquidity services to its depositors for an implicit fee. In equilibrium, this fee equals the value of the services provided. Second, the bank monitors its borrower's project to improve its chance of success.(4) Such monitoring is costly and unobservable by outsiders. Therefore, the market and the regulator make inferences about the bank's optimal level of monitoring which influence the competitive loan rate charged, as well as the regulatory capital requirement and deposit insurance premium actually imposed on the bank. In equilibrium, these inferences are correct. This paradigm yields four main results. First, under full information, banks have an interior optimum capital structure even in the absence of capital regulations. This arises due to the tradeoff between the costs of monitoring and the liquidity service fees foregone and the monitoring benefits earned through increased equity financing. Bank equityholders have a larger residual claim on the loan's payoff and thus have an incentive to increase monitoring effort to improve the loan's probability of success. Optimally, banks use greater equity financing for higher quality loans which are more sensitive to bank monitoring. This result offers a new and empirically testable rationale for the existence of depository institutions. It also provides an explanation of regulatory policy introduced by FDICIA whereby banks with high risk-adjusted capital standards are subject to less regulatory supervision since they are believed to be safer.(5) Second, under full information, social welfare is maximized if the regulator does not impose any capital requirements, when the loan and liability markets are both competitive. There are currently two opposing views in the literature on the effects of capital requirements on bank loan portfolio risk. Koehn and Santomero (1980) and Kim and Santomero (1988) argue that stricter capital requirements would not necessarily lower bank risk, whereas Keeley and Furlong (1990) and Yoon and Mazumdar (forthcoming) support conventional wisdom that they could. …