Behaviour of Capital and Risk Under Basel Regulations: A Simultaneous Equations Model Study of Indian Commercial Banks

Abstract

Implementation of Basel III guidelines necessitates, besides other measures, maintenance of additional capital buffers. The recommended capital adequacy ratio has been enhanced in phases to steer the banks gradually towards the ideal capital requirement. This study empirically examines the impact of regulations on the changes in capital and risk. An unbalanced panel data of Indian commercial banks, comprising 27 public and 31 private sector banks, is examined from 2002 to 2021. The capital adequacy ratio (CAR) maintained by the bank, against the minimum regulatory requirement, is used for the assessment of the target capital. The study employs a simultaneous equation model along with the Three Stage Least Square (3SLS) regression method. Two separate models based on risk weightage are employed to understand the relationship between capital and risk through the risk weight assignment. The findings suggest that the regulations have more impact on undercapitalized banks and the private sector banks have fared better than the public sector banks in sustaining higher CAR.