Modelling the Impact of New Capital Regulations on Bank Profitability

30 Pages Posted: 4 Sep 2014

Date Written: September 4, 2014

Abstract

This study models the impact of new capital regulations proposed under Basel III on bank profitability by constructing a stylized representative bank’s financial statements. We show that the higher cost associated with a one-percentage increase in the capital ratio can be recovered by increasing lending spreads. The results indicate that in the case of scheduled commercial banks, one-percentage point increase in capital ratio can be recovered by increasing the bank lending spread by 31 basis points and would go upto an extent of 100 basis points for six-percentage point increase assuming that the risk weighted assets are unchanged. We also provide the estimations for the scenarios of changes in risk weighted assets, changes in return on equity (ROE) and the cost of debt.

Keywords: Banks, Regulation, Basel III, Capital, Interest Income

JEL Classification: G2; G21; G28; E44; E51; E61

Suggested Citation

P.M., Vighneswara Swamy, Modelling the Impact of New Capital Regulations on Bank Profitability (September 4, 2014). Available at SSRN: https://ssrn.com/abstract=2491397 or http://dx.doi.org/10.2139/ssrn.2491397

Vighneswara Swamy P.M. (Contact Author)

IBS-Hyderabad ( email )

62, Nagarjuna Hill
Panjagutta
Hyderabad, TX AP 501504
India

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