Research On Capital Constrains,Internal Governance And Commerical Banks’ Behavior

The effectiveness and functioning mechanism of capital regulation have been the focus of financial theories and practices. However theoretical and empirical studies on this issue have revealed mixed results. After the Subprime Crisis many financial institutions meeting the capital requirement went to bankruptcy, which triggered argument on this issue again. Many banking organizations like Basel Committee believe that the capital regulation is effective although there are defects in the current system. Therefore in Oct 2010 a new framework of capital regulation was put forward in which stricter capital requirement is included. Afterwards "Commercial Bank’s Capital Management Approach (Trial)" was issued by China Banking Regulatory Commission and was formally implemented on 1st Jan 2013. As a result a multi-tier system of capital regulation is put up and the total capital requirement is stricter. It is believed that study on the impact of capital regulation on the behavior of commercial banks and the functioning mechanism is important in theory and in practice which is valuable for commercial banks and supervisors as well.This thesis is aimed to investigate the impact of capital constraints on the behavior of commercial banks in depth including the impact on risk taking behavior, capital behavior and asset allocation behavior; to testify whether the impact of capital constraint on behavior of commercial banks with different internal governance is different; to study the behavior of commercial banks affected by both capital regulation and market discipline.The thesis is organized as follows. In the first part a review is made on the literature on the impact of capital requirements on banks’ behavior focusing on the motives of capital regulation, the impact of capital regulation on commercial banks’ risk taking behavior and capital behavior, the procyclicality of this impact, the impact of capital regulation on commercial banks’ credit, etc. It is indicated that there is effect of capital regulation on commercial banks’ behavior but the functioning mechanism and result of the effect are different in different samples or samples in different period and the effect can be affected by the internal governance and market discipline.In the second part we make a theoretical analysis. Firstly a mechanism of the impact of capital requirements on commercial banks’ behavior is analyzed based on the heterogeneity of the banks which is a fundamental of the theoretical model describing the impact of capital regulation on commercial banks’ risk-taking behavior and credit allocation behavior. Secondly the internal governance is added to the model to testify the mechanism. Finally the interaction of capital regulation and market discipline is analyzed.In the third part we make an empirical analysis. Data of commercial banks in China are used to testify the capital regulation on commercial banks’ behavior. We differentiate three sub-samples of banks on the basis of their initial capitals:banks faced punishment constraints, banks faced warning constraints and banks faced high capital constraints. We testify the impact of capital constraint on commercial banks’ risk-taking behavior, credit allocation behavior and the ratio of non-interest income in these categories. Finally the internal governance is added to the model to testify whether it makes different impacts.Market discipline, minimum capital requirements and supervisory review are the three pillars in the regulatory frame of Basel Ⅱ, in which the market discipline is assumed to enhance the minimum capital requirements. Therefore a further step is made in this thesis to investigate whether there is an interaction between these two pillars especially the competition in banking is more and more fierce. If there is an interaction how to improve the performance of capital regulation with much stronger market discipline.Innovations made in this thesis are as follows:Firstly a further study is made in this thesis. We study the impact of capital regulation on the commercial banks’ behavior in a systematic way and then we add the internal governance into the model to testify whether it affects the impact. Afterwards we investigate the interaction of market discipline and capital regulation. Finally we make a conclusion of the functioning mechanism of capita regulation on commercial banks’ behavior in order to offer reference for commercial banks and related authorities.Secondly internal governance is taken into account to analyze the impact of capita regulation on commercial banks’ behavior. Direct studies are made in existing literature to find the impact of capita regulation on commercial banks’ behavior. We believe internal governance do play a role in the functioning mechanism of the impact. Accordingly a new model including internal governance is established to study the impact.Thirdly the interaction of capital regulation and market discipline is investigated. This interaction is ignored in the existing literature. In this thesis the combination of capital regulation and market discipline is made to analyze the impact on commercial banks’ risk-taking behavior. Furthermore we try to find out they substitute or supplement to each other.It is concluded that the capital constraint do affect risk-taking behavior, credit allocation behavior and ratio of non-interest income of commercial banks. However the effect is different with banks of different initial capital. Furthermore internal governance plays a role in the functioning mechanism of the effect. In 2007 the interaction of capital regulation and market discipline occurred. And according to the empirical study market contribute to the regulation on commercial banks’ risk. Accordingly the authority is suggested to make differentiated rules on commercial banks and promote positive competition. Meanwhile commercial banks are suggested to take the role of capital regulation into account when making their strategies and to improve the internal governance to make the capital regulation more effective and to speed up the transformation in face of capital regulation and liberalization of interest rates.