The implication of banking regulation on bank business model: evidence from the ASEAN countries
| DOI | https://doi.org/10.1108/JFRC-11-2020-0109 |
| Published date | 21 August 2021 |
| Date | 21 August 2021 |
| Pages | 580-603 |
| Subject Matter | Accounting & finance,Financial risk/company failure,Financial compliance/regulation |
| Author | Oktofa Yudha Sudrajad |
The implication of banking
regulation on bank business
model: evidence from the
ASEAN countries
Oktofa Yudha Sudrajad
School of Business and Management,
Institut Teknologi Bandung, Bandung, Indonesia
Abstract
Purpose –The purpose of thispaper is to examine to what extent is the impact of Basel II adoption on bank
businessmodels in the emerging market of selected ASEAN member states.
Design/methodology/approach –To evaluatethe impact of the Basel II regulation on banking business
models, a difference-in-differences estimation approach is used. This study defines bank business models
using diversificationindex of a modified Herfindahl–HirschmanIndex.
Findings –The findings suggest that the Basel II framework only affects banks’income diversification,
while there is no evidence that it leads to fundingand asset diversification. Under the Basel II accord, banks
have adjusted their business models by diversifying their sources of income to avoid the obligation for
keeping more capital;in contrast, a less developed financial market structure and a dependencyon customer
depositsare creating difficulties for banks in diversifyingtheir funding and asset structure.
Research limitations/implications –The bankingsample are taken only from ASEAN countries.
Practical implications –The findings provide important implication on the regulatory perspective,
which is the implementationof Basel II framework induces higher intensity for the use of non-interestincome
activities. Including in these activities are trading and derivatives. Accordingly, the financial authorities
should take with care the use of tradingand derivatives products in the banking industry which isalready
embeddedin current Baselframework, the Basel III Accord.
Originality/value –The paper providesdirect evidence on the impact of Basel IIon bank business models
in the emerging marketsof ASEAN banking sectors.
Keywords Basel II, Banking regulation, Difference-in-differences, Bank business models,
Banking diversification
Paper type Research paper
1. Introduction
The present paper attempts to examineto what extent is the impact of Basel II adoption in
developing countries. In this investigation, the focus is on the effects of the implementation
of Basel II on bank business models in the ASEAN member states. The evolution of banking
business models can be found in advanced economies,wherein the business models become
increasingly more complex (Demirgüç-Kunt and Huizinga, 2010;Ayadi et al., 2011;
JEL classification –G01, G21, G24, G38
This research has benefited from the financial support of the LPDP (Indonesia Endowment Fund
for Education). The Author would like to thank to the participants of the Belgian Financial Forum
2018. Finally, I thank to two JFRC reviewers for their valuable feedback.
JFRC
29,5
580
Received21 November 2020
Revised14 May 2021
Accepted2 June 2021
Journalof Financial Regulation
andCompliance
Vol.29 No. 5, 2021
pp. 580-603
© Emerald Publishing Limited
1358-1988
DOI 10.1108/JFRC-11-2020-0109
The current issue and full text archive of this journal is available on Emerald Insight at:
https://www.emerald.com/insight/1358-1988.htm
van Ewijk and Arnold, 2014;Köhler, 2015). The structural changes through regulation,
globalization of the financial market, financial innovation and technology are the factors
that foster the rapid change in the bankingbusiness models (Llewellyn, 2013). However, it is
still not clear whether those factors have the same impacts on developing countries –
especially relatedto banking regulation.
The previous studies on the impact of the implementation of Basel II focus on the
procyclicality effects (Gordy and Howells, 2006;Heid, 2007;Saurina and Trucharte, 2007;
Repullo et al., 2010;Andersen, 2011;Agénor and Pereira Da Silva, 2012), loan-loss provision
(Cummings and Durrani, 2016;Hamadi et al., 2016), loan pricing (Saurina and Trucharte, 2004;
Ruthenberg and Landskroner, 2008;Schindele and Szczesny, 2016)financial stability (Kupiec,
2007) or Islamic banking industries (Zins and Weill, 2017). However, there is a lack on literature
that evaluates the impact of Basel II on bank business models specificallyinemerging
markets. Therefore, to fill this gap, this study focuses on evaluating the implementation of
Basel II on banking business models in developing countries. Sample data from ASEAN
banking sectors is used to represent the banking industry in developing countries.
We define bank business models using diversification index of a modified Herfindahl–
Hirschman Index (HHI). A difference-in-differences (DD) estimation is applied to addressthe
study’s objective. Our findings suggest that the Basel II framework only affects banks’
income diversification, while there is no evidence that it leads to funding and asset
diversification. Under the Basel II accord, banks have adjusted their business models by
diversifying their sources of income to avoid the obligation for keeping more capital; in
contrast, a less developedfinancial market structure and a dependency on customer deposits
are creating difficultiesfor banks in diversifying their funding and asset structure.
This paper is organized as follows: Section 2 briefly describes the evolution of the Basel
regulation and reviews previous work related to the implementation of the Basel II Accord.
Section 3 explains the adoption process of the Basel II frameworkin ASEAN countries and
describes the data set used in this study. Section 4 describes the methodology used for
addressing the research objective and Section5 presents the results. Section 6 describes the
robustness checksperformed. Section 7 provides some concluding remarks.
2. Literature review
2.1 The evolution of Basel regulation
Banks as financial institutions play a vital part in a nation’s economy, in particular as
financial intermediaries. However, this role does not protect them from failing and so
severely impacting the financial stability of a given country. One of the leading causes of
banking failure is a lack of capital reserve. To address this issue, the Basel Committee on
Banking Supervision (BCBS), which consisted of central banks and financial authorities
from 10 countries, met in Basel in 1987. The main agenda was to discuss the harmonization
of capital standards in the banking industry. The committee approved what is now called
the Basel I Accord in 1988, which is an agreement on the minimum amount of capital that
banks should hold (that is, minimumrisk-based capital adequacy). The aims of Basel I were
to fortify the stability of the international banking system and to create harmonization in
regulatory standards acrossthe globe. The key achievement of Basel I lies in what might be
called “bank capital ratio.”InBasel I, bank capital is defined in two tiers: tier 1 (core capital)
and tier 2 (supplementary capital). Tier 1 capital represents a permanent source of capital
and is characterized by its high-level loss of absorbency. The tier 1 capital consists of
common stocks and declared reserves, whilethe tier 2 capital is a supplement to tier 1 and
includes all other capital such as gains on investment assets, long-term debts and other
hidden reserves. In the Basel I Accord, the credit riskis determined based on the risk-weight
Evidence from
the ASEAN
countries
581
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