Capital standards and banking stability in emerging countries: an empirical approach

Several emerging countries’ jurisdictions are going to implement Basel II prudential directives. For this reason, it is interesting to ask if capital regulation effectively contributed to strengthen banks operating in emerging markets. Throughout this paper we will attempt to give an answer to this problematic. The success of Basel I prudential mechanism known as the Cooke ratio and his adoption by the majority of emerging countries will permit us to test if capital standards, largely inspired from Cooke ratio, that regulate banks in these countries, have really influenced banks prudential behaviour. Using a non-parametric approach, we found mitigated results, since it seems obvious that more conformity of banks to capital standards induced more profitability to these institutions, restricted their leverage and strengthened their ability to hedge anticipated losses during distress episodes. However, the results also show that in emerging countries, contrary to developed countries, higher conformity to capital standards was not followed by an improvement in credit quality. Consequently, we remain doubtful toward the ability of this prudential mechanism in achieving his principal target in emerging countries’ banking systems that is reducing credit risk.