IMPACT OF RISK-BASED CAPITAL REQUIREMENT ON THE BEHAVIOR OF NIGERIAN LICENSED BANKS

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Date
2006-10
Authors
MAGANIE, AKU EMMANUEL
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Abstract
ABSTRACT Banking is an international business and its internationalization has created the need for capital standards that can be applied across national borders. It led the Bank of International Settlement (BIS) to form, in 1974, the Basel Committee on Bank Supervision Practices, which introduced risk-based capital requirements for banks. Since its introduction, the risk-based capital requirements has been acknowledged for its contribution to the widespread use of its capital ratios both as measures of the strength of banks and as trigger devices for supervisors’ intervention in banks operations. Banking is undoubtedly one of the most regulated industries in the world, and the rules on bank capital are one of the most prominent aspects of such regulation. This prominence results from the central role that banks play in financial intermediation, the importance of bank capital for bank soundness and the efforts of the international community to adopt common bank capital standards. The immeasurable attention accorded bank regulation can best be understood in its ability to alter social progress. This study attempts to analyse the impact of risk-based capital requirement on the behavior of Nigerian licensed banks form 1986 to 2004. In the simultaneous equation model, Bank capital and risk were disaggregated into major components to make policy decision and direction very effective. This was also to ensure that any change in them should not have appreciable impact on the parameters of the models except it is a sustained change. Capital was captured by regulatory pressure, returns on assets, bank size, change in risk, and previous capital stock. In the same vain, change in risk was captured by regulatory pressure, loan losses (Bad debts), bank size, change in capital and previous risk. in the other model (simple linear), the change in both deposits and loans were captured by the same variables, that is, previous total capital, change in total capital, bank size, change in loans/deposits, and national income respectively. vii The aim of this study therefore is to examine the effect of the risk-based capital requirement on the portfolio behavior of banks in Nigeria and draw inferences about the effectiveness of the Central Bank of Nigeria in bringing banks to compliance. Only secondary data were collected and estimated using both ordinary least square and two stages least square estimation techniques. The data were collected from the individual bank’s balance sheets and latter aggregated according to need. The first and most basic bank behavior concern the question whether regulatory capital requirements induce them to hold higher capital ratio while the second has to do with whether undercapitalized banks increase their capital ratios more rapidly than other banks. The next is on the adjustments to achieve the capital ratios which depending on the ratio concern, affect the numerator and denominator, that is, tier 1 and tier 2 capital respectively. The study finds that capital requirement has an impact on capital and risk adjustments in several interesting respects. In line with literature, the study find that banks adjust capital faster than risk. with respect to the coordination of capital and risk, it shows that banks with low capital buffers attempt to rebuild an appropriate capital buffer by decreasing risk when capital decrease. In contrast, banks with high capital buffers attempt to maintain their capital buffer by increasing risk when capital increase. However, banks do not adjust capital when risk changes. The study finds that Nigerian banks close to the minimum regulatory capital requirements tend to increase their ratio of capital to risk-weighted assets. This indicates that regulatory pressure, that is, the expected penalty implied by a breach of the capital requirements has the desired impact on banks’ behavior. Regulatory pressure has a positive and insignificant impact on the ratio of capital to total assets, but no significant impact on banks’ risk-taking. This indicates that for Nigerian banks, an increase in available capital through retained earnings or equity issues is less costly than a downward adjustment in viii the risk of the portfolios. However, the absence of a developed market for assetbacked securities accounts for the rigidity of their portfolios. The evidence suggests the relevance of a careful phasing in of new capital requirement in order to avoid undesirable macroeconomic side effects. In addition, notwithstanding the general recognition that capital regulation have different effects on different banks, banks capital regulation has not yet addressed the distinct needs of less developed economies which mostly rely on bank credits. The authority should devote particular attention to the process of enforcement of a stricter bank capital discipline. The presence of different bank constraints need not be read as an excuse for the failure for not modernizing capital regulation. It should instead motivate a timely revision of these constraints on the part of the individual banks and the definition of more suitable regulatory options for regulatory authorities on the part of the international standard setters.
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DEPARTMENT OF ECONOMICS AHMADU BELLO UNIVERSITY, ZARIA.
Keywords
IMPACTS,, RISK-BASED,, CAPITAL,, REQUIREMENT,, BEHAVIOR,, NIGERIAN,, LICENSED,, BANKS.
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