Capital Adequacy, Bank Behavior and Crisis: Evidence from Emergent Economies

Abstract

Using the simultaneous equations model, this paper examines the impact of capital requirements on bank risk-taking during the recent financial crisis. It also explores the relationship between capital and risk decisions and the impact of economic instability on this relationship. By analyzing the data of 46 commercial banks between 2004 and 2014 from four Middle East countries, the study concludes a positive effect of regulatory pressure on bank capital and bank risk taking. The findings reveal also that banks close to the minimum regulatory capital requirements improve their capital adequacy by increasing their capital and decreasing their risk taking. Furthermore, the results show that economic crisis positively affects bank risk changes, suggesting that banks react to the impact of uncertainty by increasing their risk taking. Finally, the estimations show a positive correlation between banks profitability and increase in capital, indicating that profitable banks can more easily improve their capitalization through retained earnings rather than issuing new securities.

 

Keywords: bank regulation, risk taking, bank capital, crisis.