| Capital adequacy ratio is one of the most important indicators for measuring commercial banks'comprehensive operating capacity and the risk-resisting ability. The introduction of the Basel Capital Accordâ…¢in 2010 further strengthened the core position of capital adequacy regulation in the global financial markets, established a comprehensive view of risk and developed the risk measurement from a qualitative analysis to an overall quantitative analysis. In 2004, China Banking Regulatory Commission promulgated the "Measures for the Management of Capital Adequacy Ratios of Commercial Banks" which reflects the the ideas of international practice and a prudential supervision of capital. Moreover, in August 2009, seven regulatory guide documents after revising lay a real subject before China's commercial banks concerning how to improve the capital adequacy management and how to adapt to changes in an international and a domestic regulatory environment, as well as stepping into a rational operating under the capital constraints.Since the advent of the Basel Accord, owing to its authority and influence as a "sacred conventions", Basel Accord immediately had the attention of commercial banks and regulators. They have taken the principles and spirit of the Basel Accord into their domestic regulation and put into implementation. Basel Accord has a very subtle and delicate risk reduction mechanism and different choices of adjusting methods will have different effects on the cost of bank capital and risk preferences, such as numerator strategies and denominator strategies. How do China's commercial banks select between the numerator and denominator strategies? What is the law of their adjusting behavior and reasons behind? What kind of adjustment mechanism is suitable for China's commercial banks? These are what this paper tried to research and explain.This paper firstly gives a general definition of commercial bank's capital adequacy ratio, followed by a summary discussion of evolution of capital adequacy calculations and the formation and development of Basel Accord. New Basel Accord issued in 2004 upheld the core position of capital adequacy ratio regulation and formed three pillars of the accord. "Measures for the Management of Capital Adequacy Ratios of Commercial Banks" also marked the intensifying of capital regulation and its integration with the international standards. In accordance with "Basel Accord", no matter the old, new orâ…¢in 2010, banks raise their capital adequacy ratio in two ways:numerator strategies by increasing the core capital or supplementary capital to increase the total amount of capital, and denominator strategies through various financial techniques to reduce the total risk exposure. In this paper, different capital sources are compared to establish a general equilibrium model. The increasingly strengthened banking capital constraints around the world make regulation to be a risk to be reckoned, namely "regulatory risk", which will raise the capital cost. The additional transaction costs and uncertainty out of lack of liquidity for bank capital cost bring a "lemon discount" to happen. The cost of bank equity will be higher than debt costs (deposits) because of lemon discount. Combined with pecking order theory, banks would hold a certain amount of additional capital, which is more than current capital adequacy requirements for a possible new capital needs. In case of a capital shortage, banks will give priority to the internal source to meet the capital requirements within a short time. However, in a long term, denominator strategies should be used. The paper also continues to derive how the change in capital adequacy requirements will affect the cost of capital and the risk preference of banks.After the introduction of current situation of capital adequacy for China's commercial banks, this paper focuses on how China's commercial banks adjust the ratio and its impact on risk preference. For that, panel data regression models and improved factors analysis of statistical index are employed to analyze the main strategies that banks in China adopt, and then this paper uses mean-variance analysis and increment decomposition of the tier 1 capital and tier 2 capital to make a further investigation. It is found that, although individual differences are obvious for adjusting method, numerator strategies still dominate for our banks. The paper points out that the reasons are:first of all, the state-owned banks are almost beyond the constraints of capital costs; secondly, in 2004, the bull stock market causes a substantial decline in bank equity capital cost; Finally, the biggest difficulty is from huge cost to fully implement a overall risk management. Next, a partial adjustment model and a stress test are conducted to verify the speed of response and the impact on banks'risk preference, based on different bank categories and different levels of capital adequacy ratio.After a detailed analysis of the reasons behind the adjustment of capital ratio for China's banks and a comparison with international large banks, especially the post-subprime crisis adjusting behavios, the paper concludes that, because of the characteristics of the capital cost, the numerator strategies entail great expense. Moreover, they are difficult to sustain due to the low efficiency in reducing the overall risk exposure. On the contrary, in China, the use of the denominator strategies makes domestic commercial banks improve the capital adequacy ratio and to enhance their risk management by taking advantage of advanced financial techniques.Finanlly, the paper suggests that based on Basel Accord, in the long term, a constant and sophisticated capital adequacy adjusting mechanism should be established. A mechanism like that will urge banks to improve the ability to resist risks and international competitiveness through internal motivation and external pressure, which is also one of the solid foundation for China's banks to fight for dominace in the fierce international competition.
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