Basel II and Bank Credit Risk: Evidence from the Emerging Markets

Networks Financial Institute Working Paper No. 2006-WP-10

41 Pages Posted: 21 Jul 2008

See all articles by M. Kabir Hassan

M. Kabir Hassan

University of New Orleans - College of Business Administration - Department of Economics and Finance

M. Ershad Hussain

University of New Orleans - College of Business Administration - Department of Economics and Finance

Date Written: October 2006

Abstract

Existing literature has focused attention on the impact of Basel I and similar capital requirement regulations on developed countries where such regulations were found to be effective in increasing capital ratios and reducing portfolio credit risk of commercial banks. In the present study, we study the impact of such capital requirement regulations on commercial banks in 11 developing countries around the world within a cross-section framework with the widely popular simultaneous equations model of Shrieves and Dhal (1992). Surprisingly, we find that such regulations did not increase the capital ratios of banks in the developing countries. This implies that particular attention should be given to the business, environmental, legal, cultural realities of such countries while designing and implementing such policies for developing countries. However, we find evidence that such regulations did reduce portfolio risk of banks. We also find that capital ratios and portfolio risk are inversely related in contrast to the predictions of buffer capital theory, managerial risk aversion theory, and bankruptcy cost avoidance theory. Our, evidence also shows that level of financial development and credit risk are inversely related implying that as the financial sector of a country develops it opens up avenues for alternative sources of finance, which results in reduced risk. Further evidence shows that liberalization is associated with bank risk.

Keywords: Basel II, Banking, Credit Risk, Emerging Markets

Suggested Citation

Hassan, M. Kabir and Hussain, M. Ershad, Basel II and Bank Credit Risk: Evidence from the Emerging Markets (October 2006). Networks Financial Institute Working Paper No. 2006-WP-10, Available at SSRN: https://ssrn.com/abstract=1065521 or http://dx.doi.org/10.2139/ssrn.1065521

M. Kabir Hassan (Contact Author)

University of New Orleans - College of Business Administration - Department of Economics and Finance ( email )

2000 Lakeshore Drive
New Orleans, LA 70148
United States

M. Ershad Hussain

University of New Orleans - College of Business Administration - Department of Economics and Finance

2000 Lakeshore Drive
New Orleans, LA 70148
United States

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