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Capital Adequacy Standards: Are They Sufficient?

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  • Rahul Dhumale
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    Abstract

    During the last two decades many countries have liberalised their financial markets. They have attempted to eliminate government intervention in setting interest rate ceilings, erecting entry barriers, interfering in credit allocation decisions, and have begun to privatise their financial institutions (FIs). However, recent banking crises have indicated a link between liberalisation and financial fragility and the subsequent trade-off between the benefits of liberalisation and the costs of increasing financial fragility in developing markets. Recent experiences in Asia have highlighted the importance of the soundness of domestic financial systems especially the need for a prudential regulatory, supervisory, and accounting framework before undertaking financial sector liberalisation. The object of the paper is to provide a link between the relative level of an individual bank's adequacy and its effects on the fragility of the banking system. Specifically, the probability of a banking crisis is modelled using the characteristics of individual banks - namely, their capital adequacy ratios. The paper concentrates on the importance of distinguishing between cosmetic and effective changes to capital adequacy ratios to avoid the systemic threats which can grow out of microeconomic weaknesses in domestic banking systems as witnessed in Asia.

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    Bibliographic Info

    Paper provided by ESRC Centre for Business Research in its series ESRC Centre for Business Research - Working Papers with number wp165.

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    Date of creation: Jun 2000
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    Handle: RePEc:cbr:cbrwps:wp165

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    Keywords: capital adequacy; banking standards; financial regulation;

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    1. Marcus Miller & Pongsak Luangaram, 1998. "Financial crisis in East Asia: bank runs, asset bubbles and antidotes," National Institute Economic Review, National Institute of Economic and Social Research, vol. 165(1), pages 66-82, July.
    2. Frederic S. Mishkin, 1996. "Understanding Financial Crises: A Developing Country Perspective," NBER Working Papers 5600, National Bureau of Economic Research, Inc.
    3. Helmut Reisen, 1998. "Domestic Causes of Currency Crises: Policy Lessons for Crisis Avoidance," OECD Development Centre Working Papers 136, OECD Publishing.
    4. Roberto Chang & Andres Velasco, 1998. "Financial Crises in Emerging Markets," NBER Working Papers 6606, National Bureau of Economic Research, Inc.
    5. Demirguc-Kent, Asli & Detragiache, Enrica, 1998. "Financial liberalization and financial fragility," Policy Research Working Paper Series 1917, The World Bank.
    6. William B. English, 1996. "Inflation and financial sector size," Finance and Economics Discussion Series 96-16, Board of Governors of the Federal Reserve System (U.S.).
    7. Roberto Chang & Andres Velasco, 1998. "Financial crises in emerging markets: a canonical model," Working Paper 98-10, Federal Reserve Bank of Atlanta.
    8. Huw Pill & Mahmood Pradhan, 1995. "Financial Indicators and Financial Change in Africa and Asia," IMF Working Papers 95/123, International Monetary Fund.
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    Cited by:
    1. Mario Tonveronachi, 2009. "Implications of Basel II for financial stability. Clouds are darker for developing countries," PSL Quarterly Review, Economia civile, vol. 62(248-251), pages 117-142.
    2. Mario Tonveronachi, 2007. "Implications of Basel II for financial stability. Clouds are darker for developing countries," Banca Nazionale del Lavoro Quarterly Review, Banca Nazionale del Lavoro, vol. 60(241), pages 111-135.
    3. Rahul Dhumale, 2000. "An Incentive Based Regulatory System: A Bridge Too Far," ESRC Centre for Business Research - Working Papers wp170, ESRC Centre for Business Research.
    4. Mario Tonveronachi, 2007. "Implications of Basel II for financial stability. Clouds are darker for developing countries," BNL Quarterly Review, Banca Nazionale del Lavoro, vol. 60(241), pages 111-135.

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