ELPR: A New Approach to Measuring the Capital Adequacy of Commercial Banks

51 Pages Posted: 28 Jun 2019 Last revised: 20 Mar 2023

See all articles by Charles M.C. Lee

Charles M.C. Lee

Foster School of Business, University of Washington; Stanford University - Graduate School of Business

Yanruo Wang

Nipun Capital

Qinlin Zhong

Fudan University-the School of Management

Date Written: February 28, 2023

Abstract

We develop and evaluate an accounting-based Loan Portfolio Risk (LPR) variable that captures time-varying contagion effects in default risk for a portfolio of bank loans. Our results show that an Equity-to-LPR ratio (ELPR) is additive in predicting bank failure up to five years in advance, after controlling for all the CAMELS variables as well as other fundamental-based bank risk measures from prior studies. Further, we find that publicly listed banks with higher ELPR have lower market-implied costs of capital, especially under market stress conditions. We conclude that ELPR captures key aspects of bank risk that are missing in current Basel Committee risk-weighted-asset calculations.

Keywords: bank regulation, bank failure prediction, financial statement analysis, risk-weighted assets, riskiness of banks, financial crisis, capital adequacy, loan default contagion, market efficiency

JEL Classification: E32, G14, G21, K23, M41, M48

Suggested Citation

Lee, Charles M.C. and Wang, Yanruo and Zhong, Qinlin, ELPR: A New Approach to Measuring the Capital Adequacy of Commercial Banks (February 28, 2023). Available at SSRN: https://ssrn.com/abstract=3410538 or http://dx.doi.org/10.2139/ssrn.3410538

Charles M.C. Lee (Contact Author)

Foster School of Business, University of Washington ( email )

224 Mackenzie Hall, Box 353200
Seattle, WA 98195-3200
United States

Stanford University - Graduate School of Business

Stanford Graduate School of Business
655 Knight Way
Stanford, CA 94305-5015
United States

Yanruo Wang

Nipun Capital ( email )

Foster City, CA

Qinlin Zhong

Fudan University-the School of Management ( email )

Shanghai, 100045
China

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