(1) Capital adequacy ratio requires reducing the possibility of bank bankruptcy.
Although some foreign studies have not found any inevitable relationship between capital ratio and bank bankruptcy probability, it is beyond reproach that capital is regarded as the last line of defense of bank bankruptcy risk. The social cost of the bankruptcy of financial institutions is far greater than the private cost, which is a prominent externality of the financial industry (Kareken and Nell,1983; Jiang Shuxia,1994; Jue Fangping, 2000). Banks are traditional financial institutions, based on the system of partial reserve of assets, and operate with high debts by converting the liquid debts provided by scattered depositors into illiquid creditor's rights to borrowers. However, the inherent high risk of banks is caused by the essential mismatch between hard assets with poor liquidity and soft liabilities with poor liquidity.
Banks are facing huge external costs, such as the bankruptcy of other institutions, the loss of valuable credit resources, and potential problems in the payment and settlement system. This externality is aggravated by the moral hazard of banks, because regulators generally guarantee banks to avoid bankruptcy risks and provide deposit protection for depositors, which makes the income of depositors and bank debtors not well reflect the risk of bank bankruptcy.
Internalizing the cost of bank bankruptcy into bank decision-making can reduce moral hazard. Raising the minimum capital requirement can reduce the possibility of bank bankruptcy, but it does not depend on carefully adjusted regulatory measures to reflect the unique risks of all banks. If the level of all capital is relatively low, the level of bankruptcy will be high. In this case, the social cost of taking risks greatly exceeds the private cost, which increases the sensitivity of capital adequacy ratio supervision.
Banks that need to be supervised are those that are lower than the normal capital requirements and have lower expected returns. These banks seek higher-risk businesses and use financial safety nets, so bank capital requirements are the most effective for these institutions, and of course, these banks are most likely to ignore regulatory requirements.
(2) Capital adequacy supervision reflects the prudent supervision of the private cost of bank bankruptcy.
The private cost of bank bankruptcy has two forms: one is the loss of bank reputation, which is the main private cost of bank bankruptcy (O 'Hara,1983); The second is the loss of franchise value.
Traditionally, the main source of franchise value is that banks have implemented industry barriers, and the industry lacks competition and can obtain monopoly rents. High license value increases the private cost of bank bankruptcy and the private cost of bank asset risk. Demsetz( 1996) proves that banks with high license value have more capital than banks with low license value, but bear less asset risk, especially the former has better realized asset diversification. Galloway et al. (1997) also confirmed that banks with high license value are more self-binding to engage in risky business than other banks. Marcus( 1984), Keeley( 1990) and Galloway et al. (1997) even pointed out that low deposit institutions in franchise value often have the risk of moral crisis, while high deposit institutions in franchise value will take prudent actions to protect their franchise value and avoid controlled liquidation. It can be seen that the supervision of bank capital adequacy ratio should focus on those banks with low franchise value and high risks, and such institutions have no incentive mechanism to restrain themselves.
In recent years, with the financial liberalization and the increasingly fierce competition between banks and non-bank financial institutions, the monopoly rent brought by the franchise value of such banks is disappearing. Boot et al. (2000) thinks that bank credit may replace monopoly rent as a new source of franchise value. They pointed out that with finance becoming an off-balance sheet business, a good reputation has become a key factor for the success of banks. Therefore, more and more attention has been paid to credit incentives by financial enterprises. Once a financial enterprise has established its own credit, it will have a strong motivation to avoid taking too many risks in order to protect this credit. Therefore, reputation will reduce the risk of banks like monopoly rents in the past, and managers will let banks bear less risks under the measurement of work prospects and personal reputation.
If the private cost of bank bankruptcy is quite high, they must try to reduce risk exposure, such as reducing credit lines and loans. If there is a large-scale capital loss, it will lead to a sharp drop in loans, which is called credit crunch. By analyzing the behavior of Citibank in the United States in the 1920s and 1930s, we can find many interesting phenomena. In the 1920s, Citibank's loans grew rapidly. However, due to the economic crisis in the 1930s, its loans fell sharply. In the 1940s, the loan-to-capital ratio dropped from 3.3 to 0.25. This kind of austerity will also occur due to the increase of minimum capital requirements, so the capital adequacy ratio is required to remain relatively stable in the economic cycle, and capital supervision is the core content of prudential supervision of commercial banks. The existence of private cost of bank bankruptcy means that many banks, especially those with high income and better reputation in franchise value, are often more motivated to reduce risks. Calomiris(2003) proved that banks will have a strong incentive to cut loans and dividends, and reduce the risk of bankruptcy to keep it at a low level. On the other hand, in some Japanese banks, the dividend of 200 1 is higher than 1993. At that time, the Japanese economy was not depressed, and the banking industry faced many difficulties. However, due to the protection of the Japanese government, banks have not paid less dividends. Instead, they convert their capital into dividends and distribute them to shareholders. This is obviously contrary to the rational choice under the regulatory risk, and it will not help the Japanese banks to get out of the predicament.
2. It is conducive to improving the risk management and internal control of banks.
The new Basel Accord requires that the capital adequacy ratio of banks should reflect all kinds of risks faced by banks more comprehensively and fully, especially the actual risk level of banks more sensitively and accurately. The New Basel Accord encourages commercial banks to continuously improve their risk management methods and techniques, and actively adopt internal rating method, especially advanced internal rating method, to scientifically measure the default rate (PD), loss given default (LGD) and expected exposure to default value (EAD) of borrowers and debts, so as to determine the credit rating, risk pricing and capital reserve requirements of borrowers and debts. But all unified standards are definitely inappropriate, and banks need to choose methods and standards according to their own conditions. One of the goals of the Basel Committee is to encourage more banks to make efforts to the basic internal rating method and the advanced internal rating method through certain incentive mechanisms, such as withdrawing less capital reserves, thus saving capital reserves and strengthening the competitiveness of banks.
According to relevant statistics, 92% of banks follow the Basel Accord to increase their capital adequacy ratio (molecular countermeasures), ignoring the importance of risk control. Bankruptcy of banks is often related to the failure of internal control, and some banks have suffered heavy losses due to the mistakes of employees. For example, the direct cause of the bankruptcy of Bahrain Bank is that nick leeson, the futures manager of Bahrain Company in Singapore, misjudged the trend of Japanese stock market. Good internal control is associated with high franchise value and good corporate governance mechanism. Banks that have good expected returns and shareholders can exert strong influence on the operation of the institution have strong motivation to protect themselves from bankruptcy, and can implement effective risk management and internal control.
For some small banks, their franchise value is low, that is, relatively speaking, their expected returns are low and uncertain, and they lack effective market constraints, so their internal control is weak. In this way, external capital supervision becomes more important. The further development of this aspect is the application of VaR, which plays an important role in measuring market risk. It sums up all the portfolio risks of banks into a simple number, and uses the US dollar as the unit of measurement to represent the potential losses. CreditMetrics of Morgan Bank has made an in-depth discussion on quantifying credit risk. This model reflects the amount of capital that a bank or its entire credit portfolio should prepare in the face of credit tension or default risk.
Banking supervision authorities all over the world have been considering combining capital supervision with internal risk management, with the main purpose of preventing bank risks. As mentioned above, "pre-commitment" is a new method of capital supervision of commercial banks. The core content of this method is to require each bank to promise before each specified period that it will retain a certain amount of capital it deems necessary to compensate for possible transaction losses during this period, and the required amount of capital is determined by each bank independently according to the internal risk model.
3. Provide an early warning mechanism before banks have liquidity problems.
Regulators prefer that capital ratio supervision contain more information. Regulators, banks and the public should want to know when the risk of a bank's portfolio is higher, or when the combination of capital assessment and risk will issue a warning that needs attention. The current capital supervision system does not provide such an early warning system, and it will not send a signal that the bank has problems until the problem is serious enough to devour capital. The savings and loan crisis in the United States from 1987 to 199 1 reflects the huge losses caused by bank bankruptcy, and the regulators did not take timely intervention measures before the crisis came.
Capital ratio can fully reflect the data information of current or future loan losses of banks, and can be evaluated reasonably and simply. Of course, it is necessary to prevent the regulatory capital management system and risk sensitivity indicators from being too conservative, and minimize the overreaction of capital ratio when the risk assessment results change. Overreaction and underreaction are equally serious problems. The Basel Committee tries to avoid this dilemma by choosing as many parameters as possible to reduce the risk exposure factors and adjust the capital requirements accordingly. If the adjustments made by the Committee are basically correct, then the regulatory authorities, banks and markets should be able to effectively handle a large amount of information contained in the high-risk sensitive capital ratio.
Before the bank goes bankrupt, the regulatory authorities can also take the following measures: reorganize the bank, allow larger institutions to merge the bank, and reorganize other assets and liabilities, so that the problem bank can be saved in time.
References:
/wiki/ capital adequacy ratio supervision