Bank capital and risk adjustment responses to economic uncertainty: Evidence from emerging Southeast Asian economies

This paper examines how banks make capital and risk adjustments simultaneously amid economic uncertainty. Applying a simultaneous equations model with a partial adjustment for capital and risk of banks from emerging Southeast Asian economies, we show that banks pursue stability amid heightened economic uncertainty mainly by hoarding more capital buffers, while their risk adjustments are mostly unaffected or negative in few cases. Sub-sample analyses further show that less stable banks, characterized by low-capitalized and high-risk banks, raise capital buffers more rapidly to protect franchise value amid uncertainty. Moral hazard behavior among banks is not salient because neither less nor more stable banks engage in riskier undertakings amid uncertainty. Mechanism analyses show that the “wait and see”, “search for yield” and “herding” strategies of banks drive the positive nexus between economic uncertainty and banks’ capital adjustments, but generally do not condition the economic uncertainty-risk adjustment nexus.