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The empirical research of banks' capital buffer and risk adjustment decision making: Evidence from China's banks

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  • Changjun Zheng
  • Tinghua Xu
  • Wanxia Liang
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    Abstract

    Purpose–In order to improve banks' ability to fight against risks, China's financial regulatory authorities refer to the Basel Accord, and bank capital adequacy ratio is taken as an important means of control. The purpose of this paper is to investigate the internal mechanism between capital buffers and risk adjustment. Design/methodology/approach–Based on the dynamic characteristics of a bank's continuing operations, the authors established an unbalanced panel of China's commercial bank balance-sheet data from 1991 to 2009 and used the Generalized Method of Moments to examine the relationship between short-term capital buffer and portfolio risk adjustments. Findings–The authors' estimations show that the relationship between capital and risk adjustments for well capitalized banks is positive, indicating that they maintain their target level of capital by increasing (decreasing) risk when capital increases (decreases). In contrast, for banks with capital buffers approaching the minimum capital requirement, the relationship between adjustments in capital and risk is negative. That is, low capital banks either increase their buffers by reducing their risk, or gamble for resurrection by taking more risk as a means to rebuild the buffer. Moreover, the authors' estimations show that the management of short-term adjustments in capital and risk is dependent on the size of the capital buffer. Research limitations/implications–From the current research documents, there are few empirical researches on capital buffers and risk adjustment, and the research sample time limits of current papers are a little earlier. The researches did not reflect China's commercial banks' capital buffer and risk adjustment after the new Basel Accord. Practical implications–Banks' adjustment speed of target level depends on the size of capital buffer, proving that the speed of adjusting capital buffer of banks with smaller capital buffer is significantly faster than their counterparts with larger capital buffers. Originality/value–The paper uses the dynamic feature of banks' lasting operations as the logical starting point, which is ignored by the current researches, and investigates the internal mechanism between capital buffers and risk adjustment.

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    Bibliographic Info

    Article provided by Emerald Group Publishing in its journal China Finance Review International.

    Volume (Year): 2 (2012)
    Issue (Month): 2 (April)
    Pages: 163-179

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    Handle: RePEc:eme:cfripp:v:2:y:2012:i:2:p:163-179

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    Related research

    Keywords: Bank capital; Bank regulation; Capital; Capital buffer; China; Commercial banks; Portfolio management; Regulation; Risk adjustment;

    References

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    1. Aggarwal, Raj & Jacques, Kevin T., 2001. "The impact of FDICIA and prompt corrective action on bank capital and risk: Estimates using a simultaneous equations model," Journal of Banking & Finance, Elsevier, vol. 25(6), pages 1139-1160, June.
    2. Douglas W. Diamond & Raghuram G. Rajan, . "A Theory of Bank Capital," CRSP working papers 363, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
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    7. Shrieves, Ronald E. & Dahl, Drew, 1992. "The relationship between risk and capital in commercial banks," Journal of Banking & Finance, Elsevier, vol. 16(2), pages 439-457, April.
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    9. Stolz, Stéphanie & Wedow, Michael, 2011. "Banks' regulatory capital buffer and the business cycle: Evidence for Germany," Journal of Financial Stability, Elsevier, Elsevier, vol. 7(2), pages 98-110, June.
    10. Rochet, Jean-Charles, 1992. "Capital requirements and the behaviour of commercial banks," European Economic Review, Elsevier, vol. 36(5), pages 1137-1170, June.
    11. Furlong, Frederick T. & Keeley, Michael C., 1989. "Capital regulation and bank risk-taking: A note," Journal of Banking & Finance, Elsevier, vol. 13(6), pages 883-891, December.
    12. Flannery, Mark J. & Rangan, Kasturi P., 2006. "Partial adjustment toward target capital structures," Journal of Financial Economics, Elsevier, Elsevier, vol. 79(3), pages 469-506, March.
    13. Stolz, Stéphanie & Wedow, Michael, 2005. "Banks' regulatory capital buffer and the business cycle: evidence for German savings and cooperative banks," Discussion Paper Series 2: Banking and Financial Studies 2005,07, Deutsche Bundesbank, Research Centre.
    14. Windmeijer, Frank, 2005. "A finite sample correction for the variance of linear efficient two-step GMM estimators," Journal of Econometrics, Elsevier, Elsevier, vol. 126(1), pages 25-51, May.
    15. Frederick T. Furlong & Michael C. Keeley, 1991. "Capital regulation and bank risk-taking: a note (reprinted from Journal of Banking and Finance)," Economic Review, Federal Reserve Bank of San Francisco, issue Sum, pages 34-39.
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