Capital regulatory pressure, charter value and bank risk-taking: empirical evidence for China

Author:Jinyi Zhang, Hai Jiang
Position:Department of Economics, Jinan University, Guangzhou, China
Pages:170-186
SUMMARY

Purpose The purpose of this paper is to identify the effect of induced capital regulatory pressure on banks’ charter value and risk-taking, and the influence of bank’s charter value on its risk-taking under such a capital regulatory pressure. Design/methodology/approach The authors use two different estimations to check the robustness of the results. First, they apply a two-stage least squares mode to estimate the... (see full summary)

 
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Capital regulatory pressure, charter
value and bank risk-taking:
empirical evidence for China
Jinyi Zhang
Department of Economics, Jinan University, Guangzhou, China, and
Hai Jiang
Jinan University, Guangzhou, China
Abstract
Purpose The purpose of this paper is to identify the effect of induced capital regulatory pressure on
bankschartervalue and risk-taking, and the inuence of banks charter value on its risk-taking under such a
capitalregulatory pressure.
Design/methodology/approach The authors use two differentestimations to check the robustness of
the results. First, they apply a two-stage least squares mode to estimatethe impact of capital requirements
and bank charter value on bank risk-taking, with the inuence of capital regulatory and market-force
variables on bank charter value. Second,to reduce the problem of unobserved heterogeneity,the authors use
dynamic paneldata techniques as a check for robustness.
Findings The empirical results show that higher capital requirements pressure brings about a lower
charter value for banks, which in turn increases their risk-taking. The issue of banksrisk-taking is also
affectedby their size: large banks seem to be more stable than their smallercounterparts.
Research limitations/implications The authorsndings suggestthat regulatory pressure has had
the desired impact oninsolvency risk for Chinese banks due to the expected penalty triggeredby a breach of
capitalrequirements.
Practical implications It is the rst paper that investigatesthe impact of capital regulatory pressure on
risk-taking of the Chinese banking system, which sheds light on concerns about regulatory monitoring of
bank risk and capitalregulatory framework.
Social implications This paper measuresthe impact of capital regulation on Chinesebank charter value
and risk-takingand offers some support for the implementation of Basel III in China.
Originality/value The authors have constructed different measures of regulatory pressure to investigate
the inuence of new capital regulatory regime on banksbehavior. Most importantly, the exogenous changes of
bankscapital ratio induced by capital regulatory pressure during the past decade that provides a unique
opportunity to directly analyze the impact of capital regulatory pressure on bank charter value and risk-taking.
Keywords Risk-taking, Chinese banking, Capital regulatory pressure, Charter value
Paper type Research paper
1. Introduction
During the past decades, Chinas economic development has attracted great attention all
over the world. As an important part of the economy, Chinas banking system has
undergone major reforms. In particular,the China Banking Regulatory Commission (CBRC)
formally promulgatedRegulation Governing Capital Adequacy of Commercial Banks in 2004,
JEL classication G21, G28, G32
JFRC
26,1
170
Received11 January 2017
Revised21 March 2017
10April 2017
Accepted18 April 2017
Journalof Financial Regulation
andCompliance
Vol.26 No. 1, 2018
pp. 170-186
© Emerald Publishing Limited
1358-1988
DOI 10.1108/JFRC-01-2017-0002
The current issue and full text archive of this journal is available on Emerald Insight at:
www.emeraldinsight.com/1358-1988.htm
which is a milestone for the regulation of the banking sector in China.Capital requirements
had become the main banking supervisory instrument since then. This initiative increased
the capital regulatory pressure on Chinese commercial banks dramatically because the
banking system has remained undercapitalized for prolonged periods. As a consequence,
almost all commercial banks were met or exceeded the Basel I capital requirements by the
year of 2007, while only eight commercial bankswere able to meet the requirements before
the year of 2004 (CBRC, 2010). This exogenousincrease in capital regulatory pressure seems
to be a rather unique eventfor a banking system.
Unfortunately, due to the surprising lack of valid data, the impact of capital regulatory
pressure on Chinese banksbehaviorshas not been empirically tested in the literature. This
overarching research issuegives rise to several important questions. For instance, how does
induced capital regulatory pressure affect bankscharter value and risk-taking? How does
banks charter valueimpact on its risk-taking under such a capital regulatorypressure?
The purpose of this paper is to provide empirical evidence for the Chinese banking
system surrounding these questions. We examine the relationship between capital
regulatory pressure, charter value and risk-taking, using a two-stage least squares model
and dynamic panel data. Priorstudies have looked at cross-country evidence focusing on US
banks as they examine the relationship between bank regulationand risk-taking incentives.
There has been little empirical evidence about developing countriesbanks. So, one
important contribution of ourpaper is to provide further empirical evidence regarding bank
behavior by focusing on the banking system of a country in transition the Chinese
banking market. Another important contribution of our paper is that develop multiple
proxies of bank risk (for example, credit risk,insolvency risk and total risk), as well as two
different measures of regulatory pressure to check the robustness of results. We have also
checked the robustness of our results using various estimation techniques, including the
system-generalized method of moments (GMM) to reduce biases of unobserved
heterogeneity. Last but not the least, our empirical results have some important policy
implications, for example, we nd that regulatory pressure has had the desired impact on
insolvency risk for Chinese banks due to the expected penalty triggered by a breach of
capital requirements. Our ndings offersome support for the implementation of Basel III in
China that sufcient capital buffer in the banking sector is necessary to help reduce bank
risk-taking, so as to safeguardthe nancial system.
The rest of the paper is constructed as follows: Section 2 contains a briefreview of both
theoretical and empiricalliterature related to the topic. In Section 3, we describe the data and
dene the key variables used in our empirical study. Section 4 introduces the econometric
models. Section 5 provides boththe methodology and empirical results. Finally, we present
our ndings and conclusionsbriey in Section 6.
2. Related literature
2.1 Capital requirements and bank risk-taking
Capital requirements can inuence bank risk-taking incentives in several ways. There are
two possible effects. First, high initial legal capital requirements can restrict competition
and allow existing banks to accumulate market power, which can reduce bank risk-taking
incentives. Second, higher overall capital requirements induce higher xed costs, and if
fewer banks are able to afford these costs,increase capital requirements would diminish the
stability of the bankingsectors (Agoraki et al.,2011). The theories of moral hazard incentive,
charter value, agency problems and asymmetric information make an obscure theoretical
expectation.
Capital
regulatory
pressure
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