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Study of optimal capital adequacy ratios

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Abstract

In response to international financial developments after the global financial tsunami in 2008, the Bank for International Settlements (BIS) proposed Basel III in 2010, whereby banks have to increase their minimum capital adequacy ratios year by year with a goal of 10.5 % by 2019. This study looks to answer two questions: (1) Is the capital adequacy ratio of 8 % required by Basel II too low to guide banks moving toward the efficiency frontier? (2) Is Basel III’s target capital adequacy ratio of 10.5 % in 2019 so strict that it might impact banks’ efficiency? The dataset herein consists of thirty-one Taiwan commercial banks over the period 2007–2009 for a total of ninety-three observations. The empirical results indicate that as many as 93.5 % of the banks have an optimal capital adequacy ratio greater than the 8 % regulation in Basel II. Approximately 88.2 % of the banks have an optimal capital adequacy ratio higher than 10.5 %. In addition, nearly 73 % of the banks should raise their BIS ratios in order to achieve the optimal BIS ratios. Hence, higher BIS ratios required by Basel III may pilot the Taiwan banking industry to reach the efficiency frontier.

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Notes

  1. The G10 consists of Canada, France, Germany, Italy, Japan, United Kingdom, Sweden, Belgium, Netherlands, and the United States.

  2. The information is based on “Entering the financial services market in Taiwan” by PricewaterhouseCoopers in 2006.

  3. The limitation of the data is that a written-off NPL will appear as loan loss provisions that reduce profit and ROA. However, the loan loss reserves will not come off the equity until they have been written-off. The capital deduction may not occur until the loan loss reserves are deducted by the written-off NPL.

  4. In Taiwan, domestic commercial banks are not allowed to have financial subsidiaries. Therefore, there are no bank holding companies.

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Acknowledgments

The authors would like to thank the associate editor and the two anonymous referees for their constructive suggestions and comments that led to significant improvement of the paper.  Yang Li thanks Ministry of Science and Technology of Taiwan (MOST 103-2410-H-390-028-) for financial support.  We alone are responsible for any remaining errors and omissions.

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Authors and Affiliations

  1. Institute of Business and Management, National University of Kaohsiung, Kaohsiung, Taiwan, ROC

    Yang Li

  2. Department of Finance, National University of Kaohsiung, Kaohsiung, Taiwan, ROC

    Yi-Kai Chen

  3. Department of Business Management, National Sun Yat-sen University, Kaohsiung, Taiwan, ROC

    Feng Sheng Chien

  4. Graduate Institute of Commerce, College of Management, National Kaohsiung University of Applied Sciences, Kaohsiung, Taiwan, ROC

    Wen Chih Lee

  5. Commercial Banking Division I, Ta Chong Bank, Taoyuan, Taiwan, ROC

    Yi Ching Hsu

Authors
  1. Yang Li
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  2. Yi-Kai Chen
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  3. Feng Sheng Chien
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  4. Wen Chih Lee
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  5. Yi Ching Hsu
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Correspondence to Feng Sheng Chien.

Appendices

Appendix 1

See Table 8.

Table 8 Bank list
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Appendix 2

See Table 9.

Table 9 Bank’s efficiency value from 2007–2009
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Appendix 3

See Table 10.

Table 10 Banks’ ROA for 2007–2009
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Li, Y., Chen, YK., Chien, F.S. et al. Study of optimal capital adequacy ratios. J Prod Anal 45, 261–274 (2016). https://doi.org/10.1007/s11123-016-0469-z

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  • DOI: https://doi.org/10.1007/s11123-016-0469-z

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