Adjustment of Bank Capital Ratios: New Evidence From Commercial Banks

Adjustment of Bank Capital Ratios: New Evidence From Commercial Banks

Faisal Abbas
Copyright: © 2023 |Pages: 15
DOI: 10.4018/IJCFA.322552
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Abstract

This study explores the speed of adjustment of the capital ratio, regulatory ratio, and tier-‎I ‎ratio of ‎commercial banks in China by employing the GMM framework ‎from ‎‎2006 to 2020. The empirical ‎analysis reveals that banks adjust their regulatory ratio and tier-I ‎ratio faster than the capital ratio of ‎Chinses commercial banks. The findings report that the pace of ‎regulatory ratio, a tier-I ratio of ‎well-capitalized, highly liquid, and high growth banks are faster than ‎under-capitalized, low liquid ‎and low growth commercial banks in China. In addition, the speed ‎of adjustment of regulatory ‎ratio, the tier-I ratio is faster than capital ratio during the GFC-2008 in ‎China. These ‎findings suggest ‎that the regulators may consider the heterogeneity in the speed of ‎capital adjustment ‎across ‎different bank characteristics to formulate new bank regulations; ‎particularly, when ‎assessing and ‎adjusting the specific capital requirements through Pillar II of the ‎Basel III agreement.‎
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1. Introduction

The Global Financial Crisis (GFC) of 2008 exposed the global banking system's vulnerabilities ‎. It emphasized the critical role of risk-weighted capital reserves and capital buffers in mitigating ‎risk and sustaining economic growth during times of economic instability. The causes and ‎consequences of the GFC-2008 also emphasized the importance of a stable and robust banking ‎system capable of coping with unanticipated financial and economic instability. ‎Therefore, after ‎the GFC-2008 Basel Committee revised the mechanism for banks to establish capital ratios ‎during the up and downturn economic conditions as a precaution for future unexpected ‎economic events (Abbas, Ali, & Rubbaniy, 2021). This new mechanism of Basel-III for holding ‎and managing bank capital indicates that each bank requires adjusting its capital ratios. As the ‎second-largest economy globally, China has one of the largest banking industries on the ‎globe. In the past decade, the China Banking Regulatory Commission has implemented the ‎Basel-III recommendations for the minimum capital requirement of 8% for their commercial ‎banks (Huang & Xiong, 2015).

A rapidly growing literature analyzes different elements of the Basel-III ‎recommendations for banks (Agoraki, Delis, & Pasiouras, 2011; Barth, Lin, Ma, Seade, & Song, 2013; Borio & Zhu, 2012; Bougatef & Mgadmi, 2016). In a particular context, Brandao-Marques, Correa, and Sapriza (2018) explore the role of regulations and bank risk-taking, Chalermchatvichien, Jumreornvong, and Jiraporn (2014) investigate the Basel-III, capital stability, ‎risk-taking and ownership in Asian banking, and Chi and Li (2017) probe the economic policy ‎uncertainty, credit risk and lending decision in China. Chiaramonte and Casu (2017) provide ‎evidence for bank capital and liquidity for European banks, (Ding & Sickles, 2018, 2019) explore ‎the frontier efficiency, capital structure, and portfolio risk of US banks. However, one part of ‎the banking literature that is still absent is how banks change their needed capital ratios following ‎an economic downturn. Furthermore, the speed of the adjustment process to achieve their target ‎capital and variables contributing significantly to the capital adjustment process in the banking ‎sector is also critical topics brought to researchers' attention. Although a ‎few studies (Abbas et al., 2021; Bakkar, De Jonghe, & Tarazi, 2019; De Jonghe & Öztekin, 2015) ‎have investigated the process of capital adjustment for banks but the evidence is still scant and ‎inconclusive. To fill this gap the study attempts to address the following questions: Does the speed of adjustment varies across different types of capital ratios? How does the speed of capital adjustment vary across different levels of the factors for instance banks’ ‎capitalization, liquidity, growth, and economic conditions in China?

Our empirical analysis reveals that Chinese banks adjust their regulatory and tier-I ratios faster ‎than ‎their capital ‎ratio. The results support that the speed of adjustment of various capital ratios ‎of well capitalized, under-capitalized, high and low growth and high and low liquid banks of ‎Chinese banks is heterogeneous. The findings report that the pace of regulatory ratio, ‎a tier-I ratio of ‎under-capitalized banks, is lower than well-capitalized banks. Similarly, the speed of ‎regulatory ratio and the tier-I ratio of high liquid banks are quicker than low liquid banks. The rate of ‎adjustment of regulatory ratio and the tier-I ratio of high-growth banks is faster than the ‎adjustment of capital ratio. In addition, the speed of adjustment of ‎regulatory ratio, the tier-I ratio is ‎faster than capital ratio during the GFC-2008 in China.‎

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