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How a regulatory capital requirement affects banks’ productivity: an application to emerging economies

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Abstract

This paper presents a novel approach to measure efficiency and productivity decomposition in the banking systems of emerging economies with a special focus on the role of equity capital. We model the requirement to hold levels of a fixed input, i.e. equity, above the long run equilibrium level or, alternatively, to achieve a target equity-asset ratio. To capture the effect of this under-leveraging, we allow the banking system to operate in an uneconomic region of the technology. Productivity decomposition is developed to include exogenous factors such as policy constraints. We use a panel data set of banks in emerging economies during the financial upheaval period of 2005–2008 to analyse these ideas. Results indicate the importance of the capital constraint in the decomposition of productivity.

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Notes

  1. In the aftermath of the 2007–2008 financial crisis, this issue has preoccupied regulators; a member of the US Senate Banking Committee asks: “What is the true cost to national economies of higher capital requirements for banks?” Senator Kay Hargan, letter to The Economist, June 4, 2010.

  2. This shadow return is calculated from the negative of the elasticity of a bank’s cost function with respect to the level of equity capital, as shown later in the paper.

  3. Berger and Humphrey (1997) and Fethi and Pasiouras (2010) present detailed reviews of the literature on banking efficiency.

  4. In the case where a fixed level of input is the constraint, the corresponding result is that the negative of the derivative of the variable cost function with respect to this fixed input is the input’s shadow price.

  5. We are grateful to a reviewer for emphasizing the distinction between regulatory capital requirements and real balance sheet constraints.

  6. We made an exception to the Bikker and Bos filtering rules. We adjusted the permitted upper bound of the equity asset ratio to 90 % if the observation simultaneously passed the regression standardised residual test—we did so because this variable is a key aspect of our analysis. This resulted in keeping in the sample 14 observations (0.8 % of the sample), chiefly of banks in South America, that the rule based criterion would have deselected.

  7. The statistical standardised residual test has more impact on the sample selected than the rule based approach.

  8. There are multiple second order and interaction coefficients too numerous to report here.

  9. We acknowledge the suggestion of a reviewer in this comment.

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Acknowledgments

We would like to thank the anonymous referees and the participants of the VI Seminar on Risk, Financial Stability and Banking of the Banco Central do Brasil in São Paulo and our paper’s discussant, Emanuel Kohlscheen, for valuable comments and helpful suggestions.

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Authors and Affiliations

  1. Hull University Business School, University of Hull, Hull, HU6 7RX, UK

    Meryem Duygun

  2. Sheffield University Management School, University of Sheffield, Sheffield, UK

    Mohamed Shaban

  3. Department of Economics, Rice University, Houston, TX, USA

    Robin C. Sickles

  4. School of Business and Economics, Loughborough University, Loughborough, UK

    Thomas Weyman-Jones

Authors
  1. Meryem Duygun
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  2. Mohamed Shaban
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  3. Robin C. Sickles
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  4. Thomas Weyman-Jones
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Corresponding author

Correspondence to Meryem Duygun.

Appendix

Appendix

See Table 7.

Table 7 Table of composed error specifications
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Duygun, M., Shaban, M., Sickles, R.C. et al. How a regulatory capital requirement affects banks’ productivity: an application to emerging economies. J Prod Anal 44, 237–248 (2015). https://doi.org/10.1007/s11123-015-0451-1

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