Regulatory Capital and Bank Risk-Resilience Amid the Covid-19 Pandemic: How are the Basel Reforms Faring?

Abstract

In this paper, we address a long-standing policy question of whether higher levels of regulatory capital, ex-ante, makes banks risk-resilient in times of severe economic downturns. Using the Covid-19 crisis as an exogenous shock to the banking system in a difference-in-difference setting, the results indicate that banks with robust pre-crisis regulatory capital ratios are less risky (have a lower insolvency risk) relative to less-capitalised banks amid the crisis period. This suggests that the post 2007-09 Basel reforms have succeeded, to some extent, in strengthening the risk-resilience of banks during the Covid-19 economic fallout.

Keywords: COVID-19, Regulatory capital, Basel reforms, Bank insolvency risk, Government support