Bank capital and credit risk taking in emerging market economies
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Volume 6 Number 2
Bank capital and credit risk taking in emerging market economies Christophe J. Godlewski Laboratoire de Recherche en Gestion et Economie (LaRGE), Universite´ Robert Schuman, Institut d’Etudes Politiques, 47 avenue de la Foreˆt Noire, 67082 Strasbourg Cedex, France tel: + 33 (0)388 417737; fax: + 33 (0)388 417778; e-mail: [email protected]
Christophe Godlewski is a Research Fellow in Management and Finance at the Laboratoire de Recherche en Gestion et Economie (LaRGE), and Teaching Assistant at the Universite´ Robert Schuman (Strasbourg III), France. He was previously a Junior Credit Risk Analyst at the Banque Sanpaolo and the Deutsche Bank. His research interests include bank’s default, credit risk, bank regulation and supervision, emerging market economies and organisational architecture in the banking industry, and corporate governance.
ABSTRACT The primary purpose of this paper is to investigate the relationship between bank capital and credit risk taking in emerging market economies. It also investigates the influence of several regulatory, institutional and legal features on the relationship between risk and capital. The paper applies a simultaneous equations framework following Shrieves and Dahl (1992) and Jacques and Nigro (1997). The results corroborate the existing findings for US and other industrial economies, putting forward the impact of capital regulation on banks’ behaviour. The paper also shows empirical evidence on the role of the regulatory, institutional and legal environment in driving bank capitalisation and credit risk-taking behaviour in emerging market economies. Journal of Banking Regulation, Vol. 6, No. 2 2005, pp. 128–145 # Henry Stewart Publications, 1745–6452
Page 128
INTRODUCTION Bank capital regulation is usually explained in the literature by the negative external-
ities of bank default.1 Bank default generates important costs: financial losses for the stakeholders (shareholders, clients, deposits insurance fund), loss of competitiveness, and a potential destabilisation of the financial system, through the contagion mechanisms, when several individual failures lead to a banking crisis. The resolution of these failures is a waste of resources, particularly scarce in emerging market economies (EMEs).2 Bank regulation aims mainly at limiting the exposure of the deposits insurance institution, and the banker’s excessive risk-taking incentives and therefore bank-default risk. The Basel Committee from the Bank for International Settlements proposed an accord on bank capital minimum levels — the so-called Basel I Accord. It aimed at implementing regulatory requirements in terms of bank capital through the Cooke Ratio. The main aim of Basel I was to promote and achieve international convergence of standard minimum capital requirements. This was done by creating a level playing field among banks by raising capital ratios and promoting financial stability by adopting a simple approach to credit risk. The primary purpose of the risk-based standards was to m
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