Risk management capital structure and lending at banks pdf

In USA study by Sheldon find that asset volatility rose rise and decreased for both bank that increased capital and that did not. Calem and Rob quantified the effect of capital based regulation and find the U-shaped relationship between capital and risk taking.

When capital increases again, they will take higher risk again. They found that undercapitalized bank took higher risk because the cost of bankruptcy is shifted to deposit insurance. For well capitalized banks, they took higher risk because it is more profitable and there is low probability of bankruptcy.

In Japan, higher capital requirement is responded by lowering asset volatility. Konishi and Yasuda analyzed the factors determining the risk taking behaviour among Japanese commercial banks and found that risk taking activities are reduced when capital regulation is introduced see Ford and Weston, Iannota et. After controlling for size, output mix, asset quality, country and years effects, they found that ownership type and ownership concentration play an important role on risk and performance.

Private banks were more profitable than mutual and public banks. However, private banks were more profitable due to their earning asset structure rather than from superior cost efficiency. Public sector banks have poorer loan quality and higher insolvency risk. This means public banks are is relatively less profitable and riskier than other types of ownership.

Public banks rely their funding on wholesale interbank and capital market but they have higher liquidity and lower loan level. It is different from private banks that rely their funding from customer deposit and provide more loans.

In terms of cost, private and mutual banks have lower operating cost. In term of ownership concentration, there is not much significant impact on profitability. However when the ownership concentration is linked to other variables such as loan quality, asset risk and insolvency risk, higher concentration is attributable to better loan quality, better asset risk and lower insolvency risk.

Dispersed ownership banks are incurring higher cost per dollar income than concentrated one. It is in accordance with agency theory framework. Altunbas, et. They did not find any strong relationship between inefficiency and bank risk-taking. Evidence from the full sample suggests that inefficient European banks do not seem to have an incentive to take on more risk. They also find evidence that the financial strength of the corporate sector has a positive influence in reducing bank risk-taking and capital levels.

There are no major differences in the relationships between capital, risk and efficiency for commercial and savings banks although there are for co-operative banks.

In the case of co-operative banks we do find that capital levels are inversely related to risks and we find that inefficient banks hold lower levels of capital.

Brewer et. They model bank capital ratio as function of public policy, regulatory, bank specific, macroeconomic and country level financial condition. The model estimated using annual data from to for unbalanced panel of the 78 largest private banks. The study found that banks maintain their higher capital ratio when the banking sector is relatively smaller and when regulator practices prompt corrective actions more actively.

Higher capital ratio is also related to the existence of stringent capital regulations and better good corporate governance mechanism. In general, capital ratio difference among counties under investigation is in part explained by the public policy and regulatory regime applied in the countries.

Using dynamic model, banks can adjust its deposit to a desired level in continuous —time model. Banks adjust the volume of its deposit voluntary, because of two purposes: reduce leverage; or increase deposit volume. As the banks must comply with the leverage regulation, any increase in deposit will end capital binding. If restructuring asset cost apples, when banks increase deposit, banks must incur the cost and reduce the deposit to prevent from a violation of the regulation in the future.

The findings are in line with empirical studies that banks do not hold the minimum capital but have voluntary capital buffer. When banks do not have attractive investment possibility, banks prefer to reduce the deposit and increase it later in the future. Surprisingly, when the higher volatility of asset value and a lower deposit growth exist, they tend to lower cost of default cost. Lindquist studied the excess capital both for commercial and saving bank in Norway using panel data approach.

In general, saving banks are holding more capital than commercial banks. In relation to the risk, a saving bank excess capital has negative relationship. The effect of credit risk to excess capital is not significant but previous profit is. In general, high risk banks are not poorly capitalized but in reality low risk banks are having too much capital. In connection to price of subordinated debt, there is negative relationship which supports the assumption that excess capital is insured against the cost related to market discipline and supervisory action due to lower capital condition.

Small banks hold higher capital buffer than big banks. Gross domestic product GDP growth is not significant to influence the capital buffer.

Data and Variables Data In this study we use a panel set of individual commercial bank from economically important countries in ASEAN region from to The sample comprises a large set of panel data of banks over the six years under consideration.

Samples are selected merely based on the availability of the data in the Fitch Bankscope database. Table 1 presents the distribution of samples for the study. This is followed by Malaysia and Cambodia 16 percent each, Thailand 14 percent, Singapore and Brunei 4 percent and Vietnam 1 percent. All variables in this study are measured in thousand US dollar. Variables Variables to be used in this study are variables that are theoretically and empirically plausible.

The variables and definitions are presented in Table 2. We use accounting measures total banking cost to total income to measure bank cost inefficiency Tahir, , used both accounting and stochastic approaches to measure efficiency. To capture banking risk, we use loans to total assets RISK. The bank specific variables consist of net loans to total assets NLTA ; growth in loans may increase risk and therefore have an unfavourable impact on capital and bank efficiency.

Goldberg and Rai used this to account for cost differences related to bank size and for the greater ability of larger banks to diversify. Finally, the ratio of off-balance sheet items to total assets OBSTA is also included to account for off-balance sheet activities. While OBS activities help banks in increasing their sources of revenue, they also increase risks. RISK Loans to total assets. CAP Total equity to total assets. NLTA Net loans to total assets. SIZE Logarithm of total assets as indicator of bank size.

ROA Profit before tax to total assets as indicator of profitability. IRC Total interest revenue to total assets. On the inefficiency side, we expect positive sign with CAP meaning that well capitalized banks operate less efficiently. RISK will have negative signs as riskier banks increase inefficiency. Table 3 presents the descriptive statistics of the variables used in this estimation.

From observations, we can see that variable INEFF as a measure of cost to income ratio indicates the inefficiency level; the higher the value, the higher the inefficiency level. The most inefficient is 3 percent and the most inefficient is percent. The mean value is 52 percent with standard deviation of RISK has a mean value of 6. In terms of SIZE, the mean is It can be seen from NLTA where the mean is The minimum value is 0. For ROA, the mean value is 1. The lowest is The highest value of ROA is 8.

The mean value is Methodology From the literatures above, researchers underline that the relationship between capital and risk are regressed simultaneously and are interrelated. This situation is known as endogeneity. Implication in the modelling requires the use of a simultaneous equation specification and estimation methodology. To simplify, we follow the approach adopted by Altunbas et. This approach solves the availability of the data. To estimate equation 1 , equation 2 is used as instrumental variables.

The use of 3SLS is necessary as it will avoid simultaneous bias for estimated coefficients. Several studies have focused on understanding the relationship between risk and capital. They tested whether an increase in capital regulation forces bank to increase their risk or vice versa Jokipii and Milne, According to Deelchand and Padgett , their study confirmed that risk, capital and efficiency are determined simultaneously.

Using Japanese cooperative banks, empirical model shows a negative relationship between risk and level of capital. Inefficient cooperative banks operate higher risk but also hold more capital. The situation may reflect the existence of moral hazards problem. In this study, we adopt an approach taken by Deelchand and Padget and Heid et. These researchers treat efficiency, risk, and capital simultaneously. Venue: Journal of Banking and Finance Citations: 67 - 0 self. Abstract We test how active management of bank credit risk exposure through the loan sales market affects capital structure, lending, profits, and risk.

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