IDEAS home Printed from https://ideas.repec.org/a/jfr/ijfr11/v12y2021i3p92-102.html
   My bibliography  Save this article

Is Risk Based Capital Ratio a True Measure of the Soundness of Banks? Evidence From India

Author

Listed:
  • J. Navas
  • P. Dhanavanthan
  • D. Lazar

Abstract

The capital to risk-weighted assets ratio (CRAR) introduced by the Basel Committee on Banking Supervision (BCBS) of the Bank for International Settlement (BIS) is widely used as an important measure of the soundness of banks. However, international institutions, academics, and market analytics have increasingly questioned the reliability of the ratio which has been revised a number of times since its inception, to make it more robust. The main objective of the present study is to assess the adequacy of using CRAR as a measure of the soundness of banks. One of the most popular methods used for the analysis of the banks¡¯ financial soundness is CAMELS framework which uses six key dimensions: capital adequacy, asset quality, management quality, earning ability, liquidity, and sensitivity to market risk. Before the introduction of CRAR, the ratio of capital to the total assets was widely used as a measure of capital adequacy in the CAMELS framework. However, when risk-based CRAR was introduced, banking regulators and policymakers started using it in the CAMELS framework for representing capital adequacy. In this paper, we argue that CRAR, as a comprehensive forward-looking measure, encapsulates all the six dimensions of the financial soundness of banks, representing various facets of banking operations, which are covered in the CAMELS framework. We, therefore, develop a theoretical framework to establish the relationship between risk-based CRAR and the important ratios used under the CAMELS framework and then empirically investigate the relationship using a panel regression model using data of Indian banks for the period 2009¨C2018. The results indicate that CRAR has a significant and theoretically consistent relationship with all six dimensions of the CAMEL framework. The study, therefore, does not only confirm the appropriateness of using CRAR as a measure of the soundness of banks, but also opens up a debate on whether CRAR can be an alternative for the CAMELS framework.

Suggested Citation

  • J. Navas & P. Dhanavanthan & D. Lazar, 2021. "Is Risk Based Capital Ratio a True Measure of the Soundness of Banks? Evidence From India," International Journal of Financial Research, International Journal of Financial Research, Sciedu Press, vol. 12(3), pages 92-102, May.
    • Handle: RePEc:jfr:ijfr11:v:12:y:2021:i:3:p:92-102
    DOI: 10.5430/ijfr.v12n3p92
    as

    Download full text from publisher

    File URL: http://www.sciedu.ca/journal/index.php/ijfr/article/view/19895/12204
    Download Restriction: no
    File URL: http://www.sciedu.ca/journal/index.php/ijfr/article/view/19895
    Download Restriction: no
    File URL: https://libkey.io/10.5430/ijfr.v12n3p92?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    References listed on IDEAS

    as
    1. Hossain Majumder, Md. Tofael & Li, Xiaojing, 2018. "Bank risk and performance in an emerging market setting: the case of Bangladesh," Journal of Economics, Finance and Administrative Science, Universidad ESAN, vol. 23(46), pages 199-229.
    2. Dahl, Drew & Shrieves, Ronald E., 1991. "The impact of regulation on bank equity infusions," Journal of Banking & Finance, Elsevier, vol. 15(2), pages 467-468, April.
    3. 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.
    4. Berger, Allen N, 1995. "The Profit-Structure Relationship in Banking--Tests of Market-Power and Efficient-Structure Hypotheses," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 27(2), pages 404-431, May.
    5. Seba Mohanty & Jitendra Mahakud, 2018. "Commercial bank capital and risk in India: Does financial crisis matter?," Cogent Economics & Finance, Taylor & Francis Journals, vol. 6(1), pages 1520424-152, January.
    6. N/A, 2011. "The UK economy," National Institute Economic Review, National Institute of Economic and Social Research, vol. 218(1), pages 3-3, October.
    7. Aswini Kumar Mishra & Vairam Arunachalam & Debasis Patnaik (ed.), 2018. "Current Issues in the Economy and Finance of India," Springer Proceedings in Business and Economics, Springer, number 978-3-319-99555-7, March.
    8. Kleff Volker & Weber Martin, 2008. "How Do Banks Determine Capital? Evidence from Germany," German Economic Review, De Gruyter, vol. 9(3), pages 354-372, August.
    9. World Bank & International Monetary Fund, 2005. "Financial Sector Assessment : A Handbook," World Bank Publications - Books, The World Bank Group, number 7259, December.
    10. N/A, 2011. "The UK economy," National Institute Economic Review, National Institute of Economic and Social Research, vol. 216(1), pages 3-3, April.
    11. Peltzman, Sam, 1970. "Capital Investment in Commercial Banking and Its Relationship to Portfolio Regulation," Journal of Political Economy, University of Chicago Press, vol. 78(1), pages 1-26, Jan.-Feb..
    12. Tan, Yong, 2016. "The impacts of risk and competition on bank profitability in China," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 40(C), pages 85-110.
    13. Ms. Sofiya Avramova & Mrs. Vanessa Le Lesle, 2012. "Revisiting Risk-Weighted Assets," IMF Working Papers 2012/090, International Monetary Fund.
    14. Claudia Girardone & Philip Molyneux & Edward Gardener, 2004. "Analysing the determinants of bank efficiency: the case of Italian banks," Applied Economics, Taylor & Francis Journals, vol. 36(3), pages 215-227.
    15. Arturo Estrella & Sangkyun Park & Stavros Peristiani, 2000. "Capital ratios as predictors of bank failure," Economic Policy Review, Federal Reserve Bank of New York, issue Jul, pages 33-52.
    16. Nupur Moni Das & Joyeeta Deb, 2018. "A Statistical Re-assessment of Capital Adequacy and Insolvency Risk in Commercial Banks of India," Springer Proceedings in Business and Economics, in: Aswini Kumar Mishra & Vairam Arunachalam & Debasis Patnaik (ed.), Current Issues in the Economy and Finance of India, chapter 0, pages 105-118, Springer.
    17. Volker Kleff & Martin Weber, 2008. "How Do Banks Determine Capital? Evidence from Germany," German Economic Review, Verein für Socialpolitik, vol. 9(3), pages 354-372, August.
    18. Asikhia Olalekan & Sokefun Adeyinka, 2013. "Capital Adequacy And Banks’ Profitability Of Deposit Taking: An Empirical From Nigeria," Far East Journal of Psychology and Business, Far East Research Centre, vol. 13(4), pages 32-41, October.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Khurram Iftikhar & Syed Faizan Iftikhar, 2018. "The impact of business cycle on capital buffer during the period of Basel-II and Basel-III: Evidence from the Pakistani banks," International Journal of Financial Engineering (IJFE), World Scientific Publishing Co. Pte. Ltd., vol. 5(04), pages 1-20, December.
    2. Seba Mohanty & Jitendra Mahakud, 2021. "Causal Nexus Between Liquidity Creation and Bank Capital Ratio: Evidence from India," Margin: The Journal of Applied Economic Research, National Council of Applied Economic Research, vol. 15(2), pages 205-237, May.
    3. Tan, Yong & Anchor, John, 2017. "The impacts of risk-taking behaviour and competition on technical efficiency: Evidence from the Chinese banking industry," Research in International Business and Finance, Elsevier, vol. 41(C), pages 90-104.
    4. Pye, Steve & Sabio, Nagore & Strachan, Neil, 2015. "An integrated systematic analysis of uncertainties in UK energy transition pathways," Energy Policy, Elsevier, vol. 87(C), pages 673-684.
    5. Kamal Naser & Abdullah Al-Mutairi & Ahmad Al Kandari & Rana Nuseibeh, 2015. "Cogency of Capital Structure Theories to an Islamic Country: Empirical Evidence from the Kuwaiti Banks," International Journal of Economics and Financial Issues, Econjournals, vol. 5(4), pages 979-988.
    6. Olszak, Małgorzata & Kowalska, Iwona, 2023. "Do competition and market structure affect sensitivity of bank profitability to the business cycle?," Pacific-Basin Finance Journal, Elsevier, vol. 80(C).
    7. Katarzyna Kubiszewska, 2018. "Interdependence of Ratios in Banking Stability Pentagon (Wspolzaleznosc wskaznikow w Pieciokacie Stabilnosci Bankowej)," Research Reports, University of Warsaw, Faculty of Management, vol. 2(28), pages 65-79.
    8. González, Rosa Marina & Marrero, Gustavo A. & Rodríguez-López, Jesús & Marrero, Ángel S., 2019. "Analyzing CO2 emissions from passenger cars in Europe: A dynamic panel data approach," Energy Policy, Elsevier, vol. 129(C), pages 1271-1281.
    9. Susan A. Kayser & John W. Maxwell & Michael W. Toffel, 2014. "Supply chain screening without certification: The critical role of stakeholder pressure," Working Papers 2014-08, Indiana University, Kelley School of Business, Department of Business Economics and Public Policy.
    10. Oyebola Fatima Etudaiye-Muhtar & Rubi Ahmad & Taiwo Azeez Olaniyi & Bilqees Ayoola Abdulmumin, 2017. "Financial Market Development and Bank Capitalization Ratio," Paradigm, , vol. 21(2), pages 126-138, December.
    11. Francesco Aiello & Graziella Bonanno, 2018. "Multilevel empirics for small banks in local markets," Papers in Regional Science, Wiley Blackwell, vol. 97(4), pages 1017-1037, November.
    12. Samina RIAZ & Venus Khim-Sen LIEW & Rossazana Bt Ab RAHIM, 2019. "The Impact of Business Cycle on Pakistani Banks Capital Buffer and Portfolio Risk," Journal for Economic Forecasting, Institute for Economic Forecasting, vol. 0(1), pages 57-71, March.
    13. Sergio Díaz-Briquets, 2015. "Measures to Deal with an Aging Population: International Experiences and Lessons for Cuba," Annual Proceedings, The Association for the Study of the Cuban Economy, vol. 25.
    14. Fazelina Sahul Hamid, 2017. "The Effect of Market Structure on Banks’ Profitability and Stability: Evidence from ASEAN-5 Countries," International Economic Journal, Taylor & Francis Journals, vol. 31(4), pages 578-598, October.
    15. Mohammad Sofie Abdul Hasan & Adler Haymans Manurung & Bahtiar Usman, 2020. "Determinants of Bank Profitability with Size as Moderating Variable," Journal of Applied Finance & Banking, SCIENPRESS Ltd, vol. 10(3), pages 1-7.
    16. Chomik, Rafal & McDonald, Peter & Piggott, John, 2016. "Population ageing in Asia and the Pacific: Dependency metrics for policy," The Journal of the Economics of Ageing, Elsevier, vol. 8(C), pages 5-18.
    17. Li, Francis G.N. & Trutnevyte, Evelina & Strachan, Neil, 2015. "A review of socio-technical energy transition (STET) models," Technological Forecasting and Social Change, Elsevier, vol. 100(C), pages 290-305.
    18. Pankaj Sinha & Sakshi Sharma, 2016. "Determinants of bank profits and its persistence in Indian Banks: a study in a dynamic panel data framework," International Journal of System Assurance Engineering and Management, Springer;The Society for Reliability, Engineering Quality and Operations Management (SREQOM),India, and Division of Operation and Maintenance, Lulea University of Technology, Sweden, vol. 7(1), pages 35-46, March.
    19. Dahl, Drew & Spivey, Michael F., 1996. "The effects of declining capitalization on equity acquisition by commercial banks," Journal of Banking & Finance, Elsevier, vol. 20(5), pages 901-915, June.
    20. Fiordelisi, Franco & Marques-Ibanez, David & Molyneux, Phil, 2011. "Efficiency and risk in European banking," Journal of Banking & Finance, Elsevier, vol. 35(5), pages 1315-1326, May.

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:jfr:ijfr11:v:12:y:2021:i:3:p:92-102. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Gina Perry (email available below). General contact details of provider: http://ijfr.sciedupress.com .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.