Capital regulation, liquidity risk, efficiency and banks performance in emerging economies
| DOI | https://doi.org/10.1108/JFRC-09-2021-0076 |
| Published date | 14 June 2022 |
| Date | 14 June 2022 |
| Pages | 126-145 |
| Subject Matter | Accounting & finance,Financial risk/company failure,Financial compliance/regulation |
| Author | Nicholas Addai Boamah,Emmanuel Opoku,Augustine Boakye-Dankwa |
Capital regulation, liquidity risk,
efficiency and banks performance
in emerging economies
Nicholas Addai Boamah,Emmanuel Opoku and
Augustine Boakye-Dankwa
Department of Accounting and Finance, KNUST School of Business,
Kwame Nkrumah University of Science and Technology, Kumasi, Ghana
Abstract
Purpose –This study aims to examine the descriptivecapabilities of efficiency, liquidity risk and capital
risk for the cross-sectional and time-series variations in banks’performance across emerging economies
(EEs). It also examines theimpact of the 2008 global financial crisis (GFC) on the effects of capital, liquidity
and efficiencyon banks’performance.
Design/methodology/approach –The paper adopts a spatial panel model and collects data across 90 EEs.
Findings –The study shows that a surge in efficiency and liquidity improves bankperformance. In addition,
banks that finance credit creation primarily with core depositsperform better. Also, banks in EEs responded to
the GFC. The findings show that banks in EEs respond to global events emanating from the developed
economies. This indicates thatEEs banks are relatively integrated with banks in developed markets.
Originality/value –Improvement in profitefficiency and effective liquidity and capital risk management
enhancethe performance of EEs banks.
Keywords Emerging markets, Banks’efficiency, Regulation, Risk, Credit supply, Banking crisis,
Banking sector competition
Paper type Research paper
1. Introduction
The study examines the effect of capital risk, liquidity risk and efficiency on the performance of
banks in emerging economies (EEs). Banking sector performance has implications for the
economic wellbeing of nations (Batten and Vo, 2019) . For instance, banks’success has positive
effects on economic growth and social welfare improvement and minimizes the likelihood of
banks insolvencies and systemic crises (Barth et al., 2004;Fethi and Paisouras, 2010;
Morshirian and Wu, 2012; Kiovu, 2012; Rahman et al., 2015; Tan, 2018). Similarly, banks’
performance substantially impacts money market development, financial stability and
economic progression (Rachdi, 2013;Akter et al., 2019). Thus, bank intermediation success is
essential for attaining effective resource allocation in an economy and the growth and
development of nations. Therefore, banks’performance has a significant impact on the
economic development of EEs and their efforts to improve their citizens’wellbeing.
However, banks’ability to allocate resources to the productive sectors of an economy
may be influenced by their level of efficiency, capital risk and liquidity risk. These factors
may impact banks’performance and the execution of their intermediation role effectively
(Papadopoulos, 2004;Fries and Taci, 2005; Schaeck and Cihak, 2014; Rahman et al., 2015;
JEL classification –G01, G15, G21, G28, F15
JFRC
31,1
126
Received14 September 2021
Revised13 February 2022
16May 2022
Accepted21 May 2022
Journalof Financial Regulation
andCompliance
Vol.31 No. 1, 2023
pp. 126-145
© Emerald Publishing Limited
1358-1988
DOI 10.1108/JFRC-09-2021-0076
The current issue and full text archive of this journal is available on Emerald Insight at:
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Merin, 2016). Effective intermediation requires that banks have sufficient resources to meet
the future demand of funds by fund providers and borrowersat reasonable costs (Carsamer
et al.,2021). This has implications for their profitability and asset allocation function. Yan
(2019) and Bitar et al. (2016) observe that increasing liquidity and capital risks may make
banks less profitable and less solvent. Similarly, García-Herrero et al. (2009), Schaeck and
Cihak (2014), Rahman et al. (2015) and Merin (2016) show that banks’efficiency and capital
impact banks’asset quality, performance, intermediation function and their influence on
economic development. In addition, adequate bank capital protects banks against
widespread distress, enables effective and efficient banks operation and improves
performance (Abdullahi, 2013). Iannotta et al. (2007) and Saleh and Afifa (2020) argue that
higher bank capital connotes higher management quality, lower bankruptcy costs and
improved bank income and performance. A weak capital base, inefficiency and extreme
illiquidity may render banks less profitable and raise the likelihood of bank failure
(Campbell, 2007; Majumderand Uddin, 2017; Akter et al.,2018).
Bank capital has a bearing on a bank’s risk-taking incentives and performance
(Calomiris and Kahn, 1991; Mehran and Thakor, 2011; Ahamed et al., 2021). However, the
relationship between bank capital and performance is not straightforward. Mehran and
Thakor suggest that higher capitaldecreases risk-shifting and motivates owners to control
risk efficiently –this may positivelyimpact bank performance. Higher capital requirements
make banks more stable and profitable (Naceur and Kandil, 2009). This arises because
higher capital diminishes the moral hazard problem and improves shareholder monitoring
and risk control efforts (Agoraki et al.,2011; Tan and Floros, 2013). On the other hand,
Giordana and Schumacher(2017) and Calomiris and Kahn (1991) note a negative influence of
capital on performance. Calomiris and Kahn argue that agency cost rises with capital.
Therefore, rising capital minimizes the incentives for managers to be disciplined, increases
risk-taking incentives and makes banks more vulnerable. More capital reduces the credit
risk of banks’portfolios, leading to diminished performance (Giordana and Schumacher,
2017). This may be explained by thepotential effect of capital on credit creation. Increasing
capital requirements may constrain credit creation and slump performance because higher
capital requirementsraise banks’marginal cost of funding, resulting in higher lending rates.
Similarly, liquidity risk increases the vulnerability of banks (Evans and Haq, 2021).
Banks’default probability and performance are significantly influenced by liquidity risk
exposure (Brunnermeier and Pedersen, 2009;Diamond and Rajan, 2011;Arif and Anees,
2012). Higher liquidity risk holds off potential clients from banks, decreases banks’utility
and undermines bank performance (Diamond and Rajan, 2005;Ejoh et al.,2014). Thus,
Kosmidou (2008) and Rahman et al. (2015) associate higher profitability with higher
liquidity. That is, lower liquidityrisk drives performance improvement among banks. Chen
et al. (2018) argue that an illiquid bank cannot mobilize sufficient funds by increasing
liabilities or converting assets promptly at a reasonable cost. Banks’profitability may
deteriorate with risingilliquidity.
Understanding the effect of liquidity risk, capital risk and efficiency on bank
performance is essential for the growth and development of EEs. It is necessary to further
examine the response of EEs banks to global events. Though some studies have explored
the performance of banks in EEs, there exists the need to strengthen our understanding of
banks in these economies and their role in driving social welfare improvements. For
instance, there is inconclusive debate on the relationship between liquidity risk and bank
performance (Chen et al.,2018; Rahman et al., 2015; Kosmidou, 2008) and the influence of
capital on the efficiency and performance of banks (Naceur, 2003; Iannotta et al., 2007;
Francis, 2013; Lee and Hsieh, 2013; Islam and Nishiyama, 2016). Similarly, there exists
Emerging
economies
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