Regulatory Capital Requirements and Risk Taking Behaviour: Evidence from the Malawi Banking System

Abstract

Proponents of stringent regulation argue in favor of higher capital requirements that it promotes financial stability, while opponents argue that capital requirements might not enhance stability but might in fact increase a bank’s riskiness. In this paper, we test this hypothesis with a dynamic panel data model for eight Malawian commercial banks using GMM estimation technique. Our results reveal that there is high persistency in risk-taking behavior of Malawian banks. Further, the study finds that high capital ratios reduce risk-taking behavior of Malawian banks through reduction in NPLs ratio and investment in high risky-assets. Based on these results, imposition of stringent penalties on banks that fail to meet minimum capital requirements and strict enforcement of regulation is key to ensuring that all banks sustain sufficient capital buffers and hence safeguard stability of banking system. However, contrary to corporate governance propositions, the study finds that the structure of board of directors does not significantly influence the impact of capital regulation on bank risk taking in Malawi.