Determinants of bank capital profile and return performance: A comparison of prudential and functional regulation of international banks

Central to this dissertation are two related studies concerning the measurements of international bank capital profile and return performance in the contexts of prudential and functional regulation. The first study argues that the conventional measures of capital and return, such as the Basle Accord's capital standard (Basle) and the accounting-based return on capital employed (ROCE), are not adequate in capturing the overall riskiness of the banks operating and competing in the new global financial environment. The second study contends that, despite a high prospect of regulatory convergence among countries due to increasing international cooperation and multilateral reciprocity, differences in banking regulations among those countries still exist. Two alternative capital and return measures have been proposed, namely the capital-at-risk (CAR) and the risk-adjusted return on capital (RAROC), to supplement and enhance the effectiveness of conventional measures. These new measures help alleviate the problems of asymmetric information in signaling or disclosing more information about the bank's risky portfolios from financial reports based on the distribution of its loss reserves. In order to test the effectiveness of the new "capital measure," a ratio between regulatory capital and economic capital is used to indicate the degree of willingness of the bank to provide capital cushion against total risks. These two ratios are specified as the dependent variables in order to find any association with the independent variables given by functional and prudential regulations.; The first hypothesis states that functional determinants such as dynamic asset-liability gaps and opacity ratio can explain the willingness and the ability of international banks better than prudential determinants can through such standard ratios as liquidity and solvency. The second hypothesis follows that functional determinants can differentiate the willingness and ability among international banks of various countries better than prudential determinants can. Based on the pooled regression of panel data of 100 banks from 19 countries categorized into 5 regions, it is found that both functional and prudential determinants perform equally well in explaining both capital and return measures, which refutes the first hypothesis. However, both asset-liability gaps and opacity ratio from functional determinants and only solvency ratio from prudential determinants can differentiate the willingness and the ability of the banks among 5 regions. It is concluded that the new measures can effectively supplement the conventional ones in light of the second study.