Macro Determinants Of Car In Indian Banking Sector

Banks as a channel of monetary policy transmission play a very important role in facilitating the process of credit creation in an economy. It is crucial for financial stability that banks stay financially healthy. Capital Adequacy Ratio (CAR) is an important indicator of banks financial health. By nature the banking-operations and performance are subject to business cycles and fluctuations in economic activity. The global financial crisis saw the failure of financial sector giants like Lehman Brothers and banks in the U.S.A and other countries. The spread of global financial crisis worldwide attracted the interest of academicians and policy makers in banking sector and its soundness. Thus, after the financial crisis of 2008 the research on banking sector particularly CAR has gained lot of attention worldwide. Our review of extant literature highlights scanty evidence of papers examining the influence of macro-economic indicators in influencing changes in CAR of banks. We believe macro-economic variables may have a significant impact on CAR of banks as financial soundness in banks also to a large extent depends on the external factors and the state of macro-economy. Hence, this paper attempts to investigate and evaluate the impact of macroeconomic indicators on CAR for Indian banks. The study uses dynamic panel data analysis on 65 Indian commercial banks from 2007 to 2013. The findings of the study based on Generalized Method of Moments reveals that Real GDP Growth, Inflation rate, Interest rate and Exchange rate have strong impact on CAR of Indian Banks. The findings of the study suggest that the policy prescriptions that focus on the bank-specific determinants of CAR should also appropriately account for the influence of macro-economic indicators. Policy makers and regulators like Reserve Bank of India should take into consideration the effect of macroeconomic variables on CAR while framing policies on CAR and monitoring banks.