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Article
Publication date: 1 March 1996

ATUL K. SHAH

The most significant recent reform in international bank regulation has been in the area of capital adequacy, first instigated by the BASLE Committee and formally introduced in…

Abstract

The most significant recent reform in international bank regulation has been in the area of capital adequacy, first instigated by the BASLE Committee and formally introduced in 1988. These reforms have had, and continue to have, significant economic consequences. However, the concept of capital adequacy and its usefulness in bank regulation has attracted a significant amount of criticism from the academic community. This raises the question as to why it was that capital adequacy was adopted as a tool for international bank regulation, despite major concerns with its rationale and effectiveness. Although the topic of capital adequacy has attracted an increasing body of research, the reasons behind the adoption and implementation of capital adequacy by international bank regulators have remained unexamined in the literature. This paper investigates the rationale for capital adequacy, citing documentary and interview evidence surrounding the key decisions, and in the process traces the dynamics of international bank regulation. The principal finding is that regulatory reform was influenced by tradition, convenience and likely acceptability rather than by any serious considerations of regulatory objectives and potential effectiveness of the capital adequacy reforms. This corresponds to findings about the origin and dynamics of regulation in the political economy literature.

Details

Journal of Financial Regulation and Compliance, vol. 4 no. 3
Type: Research Article
ISSN: 1358-1988

Article
Publication date: 19 September 2019

Ali Jamali

The FDIC Improvement Act of 1991 sets out five categories of capital and mandates corrective action for banks. Each bank based on its capital amount fall in the certain categories…

Abstract

Purpose

The FDIC Improvement Act of 1991 sets out five categories of capital and mandates corrective action for banks. Each bank based on its capital amount fall in the certain categories or states. The purpose of this paper is to consider the effect of banking regulations and supervisory practices on capital state transition.

Design/methodology/approach

First, the authors investigate how much the practices influence banks' capital adequacy using a dynamic panel data method, the generalized method of moments. Then, to scrutinize the results of the first phase, the authors estimate the effect of practices on some characteristics of capital state transition such as transition intensity, transition probability and state sojourn time using multi-state models for panel data in 107 developing countries over the period 2000 to 2012.

Findings

The dynamic regression results show that capital guidelines, supervisory power and supervisory structure can have significantly positive effects on the capital adequacy state. Moreover, the multi-state Markov panel data model estimation results show that the significantly positive-effect practices can change the capital state transition intensity considerably; for example, they can transmit the critical-under-capitalized (the lowest) capital state of banks directly to a well or the adequate-capitalized (the highest) capital state without passing through middle states (under-capitalized and significantly-undercapitalized). Moreover, the results present some new evidence on transition probability and state sojourn time.

Originality/value

The main contribution of this paper, unlike the existing literature, is to consider the power of banking regulations and supervisory practices to improve the capital state using a multi-state Markov panel data model.

Details

Journal of Financial Regulation and Compliance, vol. 28 no. 1
Type: Research Article
ISSN: 1358-1988

Keywords

Article
Publication date: 29 January 2024

Dennis Muchuki Kinini, Peter Wang’ombe Kariuki and Kennedy Nyabuto Ocharo

The study seeks to evaluate the effect of capital adequacy and competition on the liquidity creation of Kenyan commercial banks.

Abstract

Purpose

The study seeks to evaluate the effect of capital adequacy and competition on the liquidity creation of Kenyan commercial banks.

Design/methodology/approach

Unbalanced panel data from 36 Kenyan commercial banks with licenses from 2001 to 2020 is used in the study. The generalized method of moments (GMM), a two-step system, is employed in the investigation. To increase the robustness and prevent erroneous findings, serial correlation tests and instrumental validity analyses are used. The methodology developed by Berger and Bouwman (2009) is used to estimate the commercial banks' levels of liquidity creation.

Findings

The study supports the financial fragility-crowding out hypothesis by finding a significant negative effect of capital adequacy on the liquidity creation of commercial banks. The research also identifies a significant inverse relationship between competition and liquidity creation, depicting competition's value-destroying effect.

Practical implications

A trade-off exists between capital adequacy and liquidity creation, which must be carefully evaluated as changes in capital requirements are considered. The value-destroying effect of competition on liquidity creation presents a case for policy geared toward consolidating banks' operations through possible mergers and acquisitions.

Originality/value

To the best of the authors' knowledge, this is the first study to empirically offer evidence concurrently on the effect of competition and capital adequacy on the liquidity creation of commercial banks in a developing economy such as Kenya. Additionally, the authors employ a novel measure of competition at the firm level.

Details

African Journal of Economic and Management Studies, vol. ahead-of-print no. ahead-of-print
Type: Research Article
ISSN: 2040-0705

Keywords

Article
Publication date: 28 October 2013

Li Ma, Jiayi Yang and Yong Niu

Since monetary policy has great economic impacts, before the policy implementation, careful simulation combined with real economy movement condition can predict the policy…

Abstract

Purpose

Since monetary policy has great economic impacts, before the policy implementation, careful simulation combined with real economy movement condition can predict the policy implementation effect and reduce the cost of monetary policy implementation effectively. The paper aims to discuss these issues.

Design/methodology/approach

This paper selects the large commercial banks in China as the research objects, takes commercial bank capital adequacy requirement as the threshold constraint on the traditional monetary policy transmission path, and simulates the implementation effects of policy combination by applying computer technology.

Findings

It shows that the threshold effect of capital restriction policy will affect the transmission path of monetary policy, suppress the collective irrational behavior caused by the profit maximization behavior of commercial banks, and control the excessive fluctuation of macro economy.

Research limitations/implications

If using capital adequacy constraints threshold function scientifically and appropriately, the paper can effectively eliminate the negative effect of short-term traditional monetary policy transmission mechanism, control the macroeconomic overall risk within a predetermined range, and realize the goal of monetary policy with low cost.

Originality/value

Based on the theory of credit rationing from Stigliz and Weiss, combining threshold factors of capital restraint policy with the traditional monetary policy transmission path, this paper examines that the policy combination may lead to the implementation effect. The method of simulation used in this paper has not been found in other literatures, and the results have strong implications to set up a reasonable and scientific macro-prudential banking regulation framework.

Details

China Finance Review International, vol. 3 no. 4
Type: Research Article
ISSN: 2044-1398

Keywords

Article
Publication date: 11 April 2016

Jamshaid Anwar Chattha and Simon Archer

This paper aims to provide a methodology for designing and conducting solvency stress tests, under the standardised approach as per IFSB-15, including the establishment of…

Abstract

Purpose

This paper aims to provide a methodology for designing and conducting solvency stress tests, under the standardised approach as per IFSB-15, including the establishment of macro-financial links, running scenarios with variation of assumptions and stress scenario parameters; apply and illustrate this methodology by providing a stylised numerical example through a tractable Excel-based framework, through which Islamic Commercial Banks (ICBs) can introduce additional regulatory requirements and show that they would remain in compliance with all capital requirements after a moderate to severe shock; and identify the potential remedial actions that can be envisaged by an ICB.

Design/methodology/approach

The paper uses the data of the one of the groups to which certain amendments and related assumptions are applied to develop a stylised numerical example for solvency stress-testing purposes. The example uses a Stress Testing Matrix (STeM; a step-by-step approach) to illustrate the stress-testing process. The methodology of the paper uses a two-stage process. The first stage consists of calculating the capital adequacy ratio (CAR) of the ICB using the IFSB formulae, depending on how the profit sharing investment account (PSIA) are treated in the respective jurisdiction. The second stage is the application of the stress scenarios and shocks.

Findings

Taking into account the specificities of ICBs such as their use of PSIA, the results highlighted the sensitivity of the CAR of an ICB with respect to the changes in the values of alpha and the proportion of unrestricted PSIA on the funding side. The simulation also indicated that an ICB operating above the minimum CAR could be vulnerable to shocks of various degrees of gravity, thus bringing the CAR below the minimum regulatory requirement and necessitating appropriate remedial actions.

Practical implications

The paper highlights various implications and relationships arising out of stress testing for ICBs, including the vulnerability of an ICB under defined scenarios, demanding appropriate immediate remedial actions on future capital resources and capital needs. The findings of the paper provide a preliminary discussion on developing a comprehensive toolkit for the ICBs similar to what is developed by the International Monetary Fund Financial Sector Assessment Programme.

Originality/value

This paper focuses on the gap with respect to the stress testing of capital adequacy. The main contribution of the paper is twofold. The first is the development of an STeM – a step-by-step approach, which provides a method for simulating solvency (i.e. capital adequacy) stress tests for ICBs; the second is the demonstration of the potentially crucial impact of profit-sharing investment accounts and the way they are managed by ICBs (notably the smoothing of profit payouts) in assessing the capital adequacy of the ICBs.

Details

Journal of Islamic Accounting and Business Research, vol. 7 no. 2
Type: Research Article
ISSN: 1759-0817

Keywords

Book part
Publication date: 4 October 2018

Soumya Bhadury and Bhanu Pratap

In the economic literature, a crisis has been thematically defined around bank runs, failure of large financial corporations, and financial distress. Section 1 summarizes our…

Abstract

In the economic literature, a crisis has been thematically defined around bank runs, failure of large financial corporations, and financial distress. Section 1 summarizes our learnings about international banking crisis, in terms of the origin and impact of such crises. This provides us an international benchmark before we delve deeper into India's banking distress, its size and trends. Section 2 focuses on the twin-balance-sheet crisis in India. On one side, corporate firms recklessly overleveraged, resulting in excess capacities and business diversification. On the other side, banks, both private and public, fell prey to excessive and procyclical credit lending and improper monitoring. Overall, too many projects were left too weakly monitored. Separately, we have focused on two subsections, first, how the financial institutions in India have overstretched their credit-disposal limit during market upturns. Second, we found absence of any theoretically grounded approaches to determine the capital-adequacy ratios (CARs) for the banks. In Section 3, we have identified the steps taken so far by the Banking regulator and the Government to resolve the crisis. Further, we critically examine the role of Korea Asset Management Corporation (KAMCO) towards a successful non-performing assets (NPAs) resolution in South Korea. Few key takeaways include, (1) establishing a public asset-management company (AMC) focused on maximization of recoveries and resolution of stressed assets, (2) well-defined governance structure for the AMC ensuring it works on market principles, shielded from political interferences, and (3) realistic asset valuation and transfer price that ensures limited downside risks for the public AMC.

Details

Banking and Finance Issues in Emerging Markets
Type: Book
ISBN: 978-1-78756-453-4

Keywords

Article
Publication date: 16 November 2010

Marianne Ojo

This paper not only aims to trace developments from the inception of the 1988 Basel Accord to its present form (Basel II), but also to highlight flaws inherent in the 1988 Accord…

2556

Abstract

Purpose

This paper not only aims to trace developments from the inception of the 1988 Basel Accord to its present form (Basel II), but also to highlight flaws inherent in the 1988 Accord and Basel II, by way of reference to developments which occurred during the Northern Rock Crisis.

Design/methodology/approach

The paper highlights the importance of risks through a reference to the crucial role played by capital adequacy. In drawing attention to the importance of such a role and tracing developments which have taken place since the inception of the 1988 Basel Accord, it explores and analyses efforts of the Basel Committee to address capital measurement problems and assesses the success of such efforts through an illustration of capital measurement problems which still persist. An evaluation is made of the Basel Committee's efforts to address weaknesses of the 1988 Basel Accord through Basel II. Greater in‐depth evaluation of the effectiveness of the Basel Committee's efforts are undertaken through reference to developments which occurred during the Northern Rock Crisis, which is complemented by graphs and figures.

Findings

Whilst considerable progress has been achieved, the paper concludes on the basis of the principal aim of these Accords and failures of capital adequacy to address problems related to risk, that more work is still required particularly in relation to hedge funds, liquidity risks, and those risks attributed to non‐bank financial institutions.

Originality/value

The paper not only highlights existing problems with Basel II, as revealed in the aftermath of the Northern Rock Crisis, but also draws attention to other areas which the Basel Committee and regulators need to focus on.

Details

Journal of Financial Regulation and Compliance, vol. 18 no. 4
Type: Research Article
ISSN: 1358-1988

Keywords

Article
Publication date: 25 August 2020

Rafik Harkati, Syed Musa Alhabshi and Salina Kassim

The purpose of this study is to investigate the influence of capital adequacy ratio (CAR) prescribed in Basel III on the risk-taking behaviour of Islamic and conventional…

Abstract

Purpose

The purpose of this study is to investigate the influence of capital adequacy ratio (CAR) prescribed in Basel III on the risk-taking behaviour of Islamic and conventional commercial banks in Malaysia. It also investigates the claim that the risk-taking behaviour of Islamic banks (IBs) and conventional banks (CBs) managers is identically influenced by CAR.

Design/methodology/approach

Secondary data for all CBs operating in the Malaysian banking sector are gathered from FitchConnect database for the 2011–2017 period. Both dynamic ordinary least squares and generalised method of moments techniques are used to estimate a panel data of 43 commercial banks, namely, 17 IBs and 26 CBs.

Findings

The findings of this study lend support to the favourable influence of CAR set in Basel III accord on risk-taking behaviour of both types of banks. CBs appeared to be remarkably better off in terms of capital buffers. Evidence is established on the identicality of the risk-taking behaviour of IBs and CBs managers under CAR influence.

Practical implications

Even though a high CAR is observed to hamper risk-taking of banks, the findings may serve as a signal to regulators to be mindful of the implications of holding a high CAR. Similarly, managers may capitalise on the findings in terms of strategising for efficient use of the considerable capital buffers. Shareholders are also concerned about managers’ use of the considerable capital buffers.

Originality/value

This study is among a few studies that endeavoured to provide empirical evidence on the claim that IBs mimic the conduct of CBs in light of the influence of CAR prescribed in Basel III on risk-taking behaviour, particularly banks operating within the same banking environment.

Details

Journal of Islamic Accounting and Business Research, vol. 11 no. 9
Type: Research Article
ISSN: 1759-0817

Keywords

Article
Publication date: 9 November 2015

Georgios L Vousinas

– This paper aims to highlight the new regulatory framework established by Basel III.

2654

Abstract

Purpose

This paper aims to highlight the new regulatory framework established by Basel III.

Design/methodology/approach

This paper provides a critical review of the existing literature concerning bank supervision while providing an overview of the transition from Basel I to Basel III rules and critical appraisal of the current regulatory framework. Review of the existing literature.

Findings

Basel III introduces new measures in favor of bank stability and in order to mitigate the propagation of financial shocks. But on the other hand the new regulatory framework adds an extra burden to banks’ business plans affecting credit policies and thus the real economy. Another issue that is not properly addressed is the rising of financial innovations that are able to pass by the new regulations. Overall Basel III rules are moving to the right direction but need to stay always up-to-date in order to catch up with the modern ever-evolving financial system. Pros and cons. Need for improvement.

Originality/value

The paper presents an up-to-date review of Basel rules with future prospects.

Details

Journal of Financial Regulation and Compliance, vol. 23 no. 4
Type: Research Article
ISSN: 1358-1988

Keywords

Book part
Publication date: 19 November 2018

Ahmad Azam Sulaiman @ Mohamad, Mohammad Taqiuddin Mohamad and Siti Aisyah Hashim

Purpose – This research analyses the stability of a number of banks operating in Malaysia by using descriptive statistical analysis based on internal variables. These include the…

Abstract

Purpose – This research analyses the stability of a number of banks operating in Malaysia by using descriptive statistical analysis based on internal variables. These include the characteristics of the bank, capital adequacy ratio, ratio of profitability, liquidity ratio and the ratio of bank operations.

Methodology/approach – Each bank’s stability is studied using z-score analysis. Data are sourced from the balance sheets and income statements of the banks from 2000 to 2011.

Findings – The results indicate that characteristics of a bank do influence a bank’s performance. There are significant differences in financial ratios between Islamic and conventional banking. Islamic banks provide a lower loan loss of capital to cover impaired loans than conventional banks. This provides high capital based on the mean value obtained. The capital ratio allows both sets of banks to meet the capital adequacy ratio set by the Central Bank of Malaysia. Meanwhile, in profitability ratios, conventional banks have higher returns on higher assets, whereas Islamic Banking has higher returns on higher equity. Only 8 Islamic banks and 11 conventional banks are highly stable banking institutions in Malaysia.

Originality/value – Islamic and conventional banking systems in Malaysia need further improvement to deal with unexpected economics crises and increased competition between the two. Hence, Islamic banking must be refined, especially for improving their stability to attract more investments for further development and performance.

Details

New Developments in Islamic Economics
Type: Book
ISBN: 978-1-78756-283-7

Keywords

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