The Relationship Betweenn Charter Value And Bank Capital Buffer

Capital requirement is one of the primary means of modern banking supervision. It provides a buffer for the bank when facing disadvantage economic situation and provides advance prevention mechanism for over risk-taking. According to the traditional bank risk management theory, because of the limited liability and the dominant (hidden) existence of the deposit insurance system, the bank will lower capital ratios to choose the investment portfolio with higher risk, so as to upgrade the ruin probability sharply. However, actually, banks of all countries do not only meet the requirements of minimum capital adequacy, but also hold a certain amount of additional capital cushion. These bank behaviors, which are contradictory to the traditional theory, make the academic find and define the concept of bank charter value. The charter value discipline theories consider banks with a valuable charter will hold a significant amount of capital against market risk since they have enough incentive to prevent the failure of the bank. However, the traditional charter value theories fail to recognize the endogenous nature of bank capital decisions and are unable to explain many aspects of bank capital. A large body of empirical literature has found that the bank with high charter value doesn’t hold the largest mount of capital buffer. Then, the more recent capital buffer theory introduces a dynamic aspect whereby a bank is faced with implicit and explicit costs of maintaining an internally defined target level of capital. As the charter value starts to fall, banks are encouraged to hold larger capital buffers so as to protect the valuable charter. When the charter value falls below a certain threshold, this relationship reverses.Along with the financial integration accelerated, countries in the world gradually accelerate the financial liberalization reform process. A more liberal policy environment, the increasingly fierce industry competition, making the charter value of the banks has been severely eroded and further affecting the banks’ capital behavior. Because of China’s special national conditions and the late starting of the financial industry, we need further research and discussion about how the banking competition affects charter value and how the charter value affects bank capital decision. Based on the theory of capital buffer, we analyze the effect charter value acts on bank capital buffer with capital endogenous dynamic model. We predict the relationship between charter value and bank capital buffer is non-linear. However, once charter value rise above a certain threshold, banks maintain a capital buffer. As the charter value starts to fall, banks are encouraged to hold larger capital buffers so as to protect the valuable charter. When the charter value falls below a certain threshold, the bank loses the incentive to hold capital buffer and the model reverts back to a simple pure static moral hazard case. Then, we adopt8-year data of Chinese16listed banks to spread out study in empirical analysis with multi-steps dynamic regression model:In the first-step, we analysis the affections banking competition acts on charter value; in the second-step, we adopt linear, quadratic, and threshold estimation techniques to estimate the relationship between charter value and bank capital buffer. The results indicate that the relationship between banking competition and charter value and the relationship between charter value and bank capital buffer are both non-linear consistent with theoretical prediction. And the results can be confirmed by the robustness checks.