The Impact Of Capital Requirements On Bank Capital And Risk:Empirical Evidence From Listed Banks In China

Capital requirement has become one of the most important instruments for regulating modern banks. It can act as a cushion under adverse economic conditions and prevent banks from excessive risk taking. Research on the relationship between risk and capital has important implications. Since the BCBS promulgated Basel III in2010and required banks to maintain a higher amount of capital, the CBRC released a new rule for regulating the capital adequacy requirement of commercial banks as a response to Basel III at the end of2012. The primary goal of the CBRC is to improve the ability of banks to absorb asset losses without affecting the rest of the economy. However, under implicit state guarantee, commercial banks in China may increase their portfolio risk taking, thus may weaken the effect of capital regulation. In such case, the enhancement of capital requirement would pose systemic risk to financial system.This paper aims to assess the impact of Basle Accord regulation on listed bank’s capital and risk in China. A simultaneous equation model developed by Shrieves and Dahl (1992) is used to capture the relationship between risk-based capital standards and bank portfolio risk. The model is estimated and tested using three stage least squares (3sls) procedures on a three dimensional panel of individual banks across14listed banks in China and across annual observations in the2004-2011period. Dummy approach and a rolling window approach are used to investigate the relationship. Under the system GMM and the3sls procedures, it is found that banks prefer to increase their speed of capital adjustment and decrease their speed of risk adjustment when they can determine capital and risk simultaneously comparing with separately. The capital requirements significantly affect banks’ capital ratio decisions and the regulatory pressure does not affect their chosen risk level. This finding indicates that the coordination of capital and risk adjustments runs only from capital to risk and not vice versa. Afterwards, we divided14listed banks into three groups as subsamples for examining the regulatory impacts. The results turn out that different bank group shows different react to the regulatory pressure. The finding suggests that although the BCBS set a single criterion ignoring the difference of commercial banks in China in the last twenty years, regulatory pressure was successful in raising the capital to risk-based assets of undercapitalized banks. Furthermore, facing the increasing capital requirement, banks in China need to balance the relationship of capital and risk, change their business pattern and pursue a capital intensive development path.This paper has four chapters. Chapter one is preface introducing research background and study objects. The theoretical literature and empirical literature overviews are also included. Chapter two focuses on describing the risk based capital requirement proposed by the BCBS and its application in China. Chapter three is the most important part of this paper. It does empirical research on all14listed banks and its subsamples with two different approaches as mentioned in the last paragraph. A comparison with domestic research is showed in a table at the end of this chapter. The last paragraph is about inspiration from the empirical research and some suggestion on the future research.