Capital regulation and ownership structure on bank risk
| Pages | 39-56 |
| DOI | https://doi.org/10.1108/JFRC-02-2019-0015 |
| Date | 11 October 2019 |
| Published date | 11 October 2019 |
| Author | Aysa Siddika,Razali Haron |
Capital regulation and ownership
structure on bank risk
Aysa Siddika
Kulliyyah of Economics and Management Sciences,
International Islamic University Malaysia, Kuala Lumpur, Malaysia, and
Razali Haron
IIUM Institute of Islamic Banking and Finance,
International Islamic University Malaysia, Kuala Lumpur, Malaysia
Abstract
Purpose –This paper aims to examinethe impact of capital regulation, ownership structure and the degree
of ownershipconcentration on the risk of commercial banks.
Design/methodology/approach –This study uses a sample of 565 commercial banksfrom 52 countries
over the period of 2011-2015. A dynamic panel data model estimation using the maximum likelihood with
structuralequation modelling (SEM) was followed consideringthe panel nature of this study.
Findings –The study found that the increase of capital ratio decreases bank risk and the regulatory
pressure increases the risk-taking of the bank. No statistically significant relationship between banks’
ownership structure and risk-taking was found. The concentration of ownership was found negatively
associated with bank risk.Finally, the study found that in the long term, bank increases the capital level that
decreasesthe default risk.
Originality/value –This study presents an empirical analysis on the global banking system focusing on the
Basel Committee member and non-member countries that reflect the implementation of Basel II and Basel III.
Therefore, it helps fill the gap in the banking literature on the effect of recent changes in the capital regulation on
bank risk. Maximum likelihood with SEM addresses the issue of endogeneity, efficiency and time-invariant
variables. Moreover, this study measures the risk by different proxy variables that address total, default and
liquidity risks of the banks. Examining from a different perspective ofrisk makes th e study more robust.
Keywords Ownership structure, Risk taking, Capital regulation, Dynamic panel
Paper type Research paper
1. Introduction
During the 2007-2008 global financial crisis, excessive risk-taking by financial firms and
lapses in the regulatory framework were identifiedas major causes of the crisis (IMF, 2014).
Adding to this, lack of adequate capital against the assets of the banks, too much
dependency on the credit rating of the assets in calculatingthe required level of capital and
reducing the capital level acceleratedinvestments in risky assets significantly caused banks
to become insolvent duringthe 2007-2008 financial crisis (Acharya and Matthew, 2009).
Excessive risk-taking by lending in risky assets can increase the rate of default in
repayment and return of the banks, which ultimately affect the depositors. The aggregate
defaults by banks consequentlyaffect the economy as a whole. Capital adequacy regulation
intended to address this risk-taking behaviour provides comprehensive guidelines in
managing bank capital by the Basel Committee. The 2007-2008 global financial crisis has
caught the distinguished attention of the supervisory and regulatory authorities, and the
effect of regulatory enforcement of capital adequacy regulation has gained a lot of
motivation in the recentempirical studies on bank risk.
Capital
regulation on
bank risk
39
Received14 February 2019
Accepted23 August 2019
Journalof Financial Regulation
andCompliance
Vol.28 No. 1, 2020
pp. 39-56
© Emerald Publishing Limited
1358-1988
DOI 10.1108/JFRC-02-2019-0015
The current issue and full text archive of this journal is available on Emerald Insight at:
https://www.emerald.com/insight/1358-1988.htm
Even though the regulation is implemented to strengthen the banking system, existing
empirical evidence advocates the negative effect of regulatory pressure hypothesis to
encourage excessive risk-taking in the banking industry (Lundtofte and Nielsen, 2018;
Bouheni, 2014;Camara et al.,2013;Murphy, 2013;Matejasak et al., 2009;Hussain and
Hassan, 2005;Diamondand Rajan, 2000;Blum, 1999;Shrieves and Dhal, 1992).
Over time, the banking industry has transformeda lot in terms of operation, competition
and product innovation (Barry et al.,2011). Along with these transformations, the industry
was driven by several bank failures and financial crises that have changed the operating
regulations significantly to become more stringent. Hence, the effect of regulatory
enforcement on capital adequacy regulation has gained a lot of attention in the recent
empirical studieson bank risk but has not achieved any consensus on the result.
To understand the effect of the capital regulation, it is necessary to consider the bank’s
ownership structure, as ownership type and degree both shape risk-taking decision of the
banks (Tran et al., 2018;Laevenand Levine, 2009). Same regulation may result differently in
different ownership compositionof the banks. Because agency issues have different impact
on capital and risk, ownership structure should be considered in testing the relationship
between these variables (Barry et al., 2011;Altunbas et al., 2007). Thus, the present study
expects a varying impactof ownership type and the degree of ownership on bank riskin the
presence of the capital adequacyregulation.
This study analyses the effect of capital regulation and ownership structure on the risk-taking
of commercial banks over the period of 2011-2015 and contributes to the existing literature by
assessing the effect of shareholder entity, characterised by the ownership controlled by the
financial institution or not, where the evidence is limited. A number of studies examining the
effect of capital regulation on bank risk are evident for the US, EU, Asian, advanced and
emerging economies from country-specific or cross-country positions. The significance of this
study is that it presents an empirical analysis in the global banking system focusing on the Basel
Committee member and non-member countries that reflect the implementation of Basel II and
Basel III. Therefore, it helps fill the gap in banking literature on the effect of recent changes in the
capitalregulationonbankriskinglobalbanking system. Because there is no single definition of
risk, this study defines risk from three aspects, i.e. total risk-weighted asset (RWA) ratio, Z-score
and liquidity ratio which address the total, default and liquidity risks of the banks, respectively.
Most of the existing studies use proxy variables that represent the credit risk (Maji and Kumar,
2015), Z-score (Haque, 2018) and the variability of return (Bouheni, 2014) to measure the risk of
the banks. Proxy variables to measure the aggregate risk of the banks are limited and address the
period of Basel Accord I (Shehzad et al., 2010;Hussain and Hassan, 2005).
Moreover, this study uses the maximum likelihood estimation (MLE). In parameter
estimation, MLE is a consistent approach. MLE of structural equation models is more
efficient than the generalized method of moments (GMM) method (Allison et al., 2017), and
the endogeneity issues in dynamic panel data can be addressed by MLE of structural
equation models. MLE with SEM is followed to resolve the issue of endogeneity,
autoregression,efficiency and time-invariance variables.
This study examines the effect of capital ratioand stringency of capital regulation on the
risk of commercial banks. To find out the varying impact of ownership entity and
ownership concentration,this study focuses on the percentage of ownership by the ultimate
owner and whether the bank is owned by any financial institutions. The study found that
though the increase of capital ratio decreases the risk-taking of the banks, stringent capital
regulation in initial capital build-uphas an adverse effect on the risk-taking behaviour of the
banks. The study identified that the initial stringent regulatory constraint in raising bank
capital encourages managers to increase the risk of the banks to raise the return of assets.
JFRC
28,1
40
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