Bank Capital Adequacy: The Impact Of Fundamental And Regulatory Factors In A Developing Country

Abstract

This paper provides evidence that the overcapitalized banks are much more sensitive to fundamental factors rather than to the regulatory requirements such the Basle’s Accord requirements, which raises the question of whether Basel’s limits are sufficient to minimize financial crises. Also, keeping buffers against falling below the minimum requirements appear to be of second order importance. Three fundamental factors affect capital adequacy in Jordan; risk, return and activity. Risk indicators drive the capital adequacy ratios downward. Return on average assets (ROAA) has the biggest impact among all factors, banks fuel their capital internally following the pecking order theory, and they also raise capital whenever their activities (loan to asset ratio) improve. Return on average equity (ROAE) is a cost factor; banks avoid issuing capital whenever cost of common equity is high. This paper also provides evidence that systematically important banks hold less capital, a sign of moral hazard.